SteadyOptions is an options trading forum where you can find solutions from top options traders. TRY IT FREE!

We’ve all been there… researching options strategies and unable to find the answers we’re looking for. SteadyOptions has your solution.

Trade Size: Taming The 800-Pound Gorilla


I often refer to selecting a proper position size as the easiest and most important risk-management technique for the individual trader. It is always tempting to trade bigger size, especially when confident. Big size can produce big profits. Traders believe that earning bigger profits is the path to wealth.

What's Your Maximum Loss?

 

However

  • Being confident does not guarantee that the markets will behave
  • Overconfidence leads to ignoring risk management
  • Big size can produce devastating losses
  • The Risk of Ruin increases exponentially as trade size increases
  • Preventing big losses represents the successful trader’s path to wealth

Most beginners are shy about making a big monetary commitment and usually start trading with a small investment. When buying options, they set a maximum dollar amount to be invested. It is obvious that the cost of the options represents the most that can be lost.

 

However, when adopting any of the ‘income generating’ strategies, even though the trader may know the results of the worst case scenario, it is often difficult to recognize that such losses do occur. Why is that? I believe it is the result of a natural optimism that accompanies the discovery of options as an investment tool. The conservative trader begins with one-lots. She progresses as her confidence and experience grow.

 

The aggressive trader, who does not (yet) understand how important risk management is to his future success, may begin trading positions that are large enough to destroy 25 to 50% of his account value in a single trade.

 

Let’s take a detailed look at how a trader – especially a new trader – is supposed to determine an appropriate trade size.

 

Hi Mark,

 

I saw your webinar “Can you earn a steady income with Options – The Career Plan.”

 

You discuss a $50k account and suggest that $40k of margin be used, with $10k left for adjustments or other trades.

 

In that $40k you discuss that if we are doing 10-point credit spreads, then the margin required is $1k per spread – so you can take a max of 40 IC’s – so that means if one is doing trades expiring in 2 different months, then that’s 20 IC’s for each expiry.

 

What's the optimal Trade Size?

 

So in short, with a $50k account, a good plan would be to take 20 IC’s in each of those 2 expiring months.

 

‘Good plan’? That depends on the trader.

 

But, yes, that is what I recommend as the MAXIMUM trade size. It is ALWAYS acceptable to trade less size.

 

It is always safer to keep more money on the sidelines for repairing trades gone awry.

 

One of the worst feelings of helplessness occurs when you are losing money, the market is moving against your position, you see an excellent trade that reduces risk and solves your temporary problem – only to discover that the trade increases the margin requirement and you lack the funds to make the trade.

 

I confess that I did not emphasize that the plan I suggested in the video represents the MAXIMUM trade size. I do not want anyone to believe that an inexperienced trader can handle 40 iron condors when the account size is $50,000. Many experienced traders would find that trade size to be far outside their comfort zones.

 

senior-position-sizing2-101.png

 

If you are not a member yet, you can join our forum discussions for answers to all your options questions.

 

Any trader’s individual skill and experience play a large role in determining how much cash you want to hold as a cushion.

 

We must recognize that 20-lots of a 10-point iron condor may not seem too big to handle. And most of the time that is true. However, it is possible to lose as much as $700 or $800 per spread. That unlikely, but possible, loss of $14k to $16k is far too much for a $50k account.

 

Are You An Experienced Trader?

 

The experienced trader; the disciplined trader; the trader who knows that he/she does have the will power to do what is necessary and take appropriate action to insure survival – even it means locking in a big loss; that trader can handle positions of this size.

 

When I refer to a trader who has the will power – I am referring to someone who has done it – more than once. It is far too easy for the less-experienced trader to look at a $5,000 loss and refuse to accept the fact that a given trade is not going to work. The trader who hates losing that much and wants ‘his/her money back’ is not going to be a successful trader. When money has been lost, it is no longer your money. It belongs to someone else. That traders JOB is to salvage his account by fixing the problem. That is accomplished by exiting the trade, reducing size, or making a risk-reducing position adjustment.

 

If you do not know FOR A FACT that you will have the courage – and it does take courage to face reality – that you will act to prevent larger losses and that you will not just close your eyes and hope that the market reverses direction – then you are not yet ready to trade bigger position size. Have patience, gain experience, and trade far below the recommended maximum.

 

I repeat: I did not emphasize those points when making that video.

 

The video discussion was about the minimum amount of spare cash an iron condor trader should keep available. More cash increases the probability that you be able to handle any crisis and survive for the long term.

 

I do understand that you will probably never lose the maximum, because you would adjust and reduce risk. However, are you positive that you would not panic or refuse to act? Do you really want to bet your entire trading account on that possibility?

 

We recognize that the maximum loss is possible if the market crashes, and we do want to think in terms of a worst-case scenario when looking at risk. But one note: If the market crashes, IV will be sky high. Those very deep ITM put spreads will not be trading near $10. You would be able to cover at a price of $7 to $9. You may not want to do that, hoping for a reversal, but the maximum loss would not occur right away, unless it is expiration day.

 

The way I have read about managing risk is to decide how much you are going to risk on each trade. So let’s say I had a $50k and I decide I will not risk more than 4% per trade – so 4% of 50k is $2k. In the above scenario where the risk per IC was $820 I would only do a maximum of 2 or 3 IC’s ($2k divided by $820).

 

Could you advise the pros and cons of each – surely the 20 IC’s will provide much higher return.

 

Yes, the cash returns could be very high. But more than that, the loss potential is also high. Too high in my opinion.

 

As far as risking 1, 2, or 4% of the account value on a trade, that is not for traders who do as we do. That is for the day- or swing-trader or who buys stocks (futures etc). We can take a little more risk per trade because the chances of losing the maximum are very small. That is not true for the day trader. That day trader (or investor) could establish a stop loss at that 2% or 4% level. Losing that maximum is not a rare situation.

 

Similarly, an investor who follows your suggested rule could own more than 20 simultaneous investments. That works for the longer-term investor who does not have to make moment-to-moment trade decisions.

 

We, and our positions, do not allow for convenient stop loss orders (for many reasons). But that does not mean we should go as far as putting 16k (32% of the account) at risk for any trade. We need a more reasonable limit.

 

I am comfortable telling you that if you own two 10-lot iron condors – that is reasonable trade size despite the possibility of losing $8k on each spread, IF AND ONLY IF

  • You are comfortable with that size
  • You have experience making adjustments and taking losses

You are not nervous with that size (within comfort zone)

 

If it is early in your career, I would be more comfortable suggesting that you trade two three-lots positions.

 

Related articles:

 

 

Trading An Iron Condor: The Basics

Trade Iron Condors Like Never Before

Why Iron Condors are NOT an ATM machine
Why You Should Not Ignore Negative Gamma

Are You Ready For The Learning Curve?

How Position Sizing Impacts Your Returns

Adaptability And Discipline

 

Want to learn how to reduce risk and put probabilities in your favor? We discuss how to do it on our forum.


Start Your Free Trial

What Is SteadyOptions?

Full Trading Plan

Complete Portfolio Approach

Diversified Options Strategies

Exclusive Community Forum

Steady And Consistent Gains

High Quality Education

Risk Management, Portfolio Size

Performance based on real fills

Try It Free

Non-directional Options Strategies

10-15 trade Ideas Per Month

Targets 5-7% Monthly Net Return

Visit our Education Center

Recent Articles

Articles

  • Great reversal signal – 50 MA with 8 EMA

    Options traders continually seek the elusive “sure thing” reversal signal. Of course, there is no such thing. But there are ways to use combined signals to identify likely reversal points. Add in strong confirming signals, and you have a reliable system for entering and exiting options trades.

    By Michael C. Thomsett,

    • 0 comments
    • 172 views
  • Why Bother with Annualized Return?

    Most options traders realize that annualizing returns does not reflect what you can expect to earn consistently. It is, however, a way to make relevant comparisons between outcomes of different holding periods.The first big question is, What is the basis for calculating a net return?

    By Michael C. Thomsett,

    • 0 comments
    • 1,323 views
  • Is 5% a Good Return For Options Trades?

    I'm often asked if 5% is a good return for an options trade. The answer is: it depends. One of the myths of options trading is that you should aim for at least 100% gain in each option trade, otherwise it is not worth the risk. Is it really the case?

    By Kim,

    • 0 comments
    • 399 views
  • How to Trade Volatility

    When trading options, one of the hardest concepts for beginner traders to learn is volatility, and specifically HOW TO TRADE VOLATILITY. After receiving numerous emails from people regarding this topic, I wanted to take an in depth look at option volatility.

    By GavinMcMaster,

    • 0 comments
    • 1,511 views
  • The Real Meaning of the Efficient Market Hypothesis (EMH)

    Most traders have heard of the efficient market hypothesis (EMH) and most believe they know what it means. In a nutshell, it is a belief that the market is “efficient” and that the current price of shares is a reflection of efficiency. Right? Wrong.

    By Michael C. Thomsett,

    • 0 comments
    • 995 views
  • Put Permanent Portfolio

    Harry Browne popularized the concept of the "Permanent Portfolio" decades ago by recommending an asset allocation of 25% stocks, 25% bonds, 25% gold, and 25% cash. In the 90's, the concept of "risk parity" also became popular with writings by Cliff Asness of AQR Capital.

    By Jesse,

    • 0 comments
    • 1,511 views
  • Does HFT Harm Individual Investors?

    What is the overall impact of High Frequency Trading (HFT)? Some traders believe that the use of algorithms in super-fast and powerful computers allows large hedge funds and other institutions to beat the market, implying that because these big traders can out-perform individuals, profits are unfairly gained. But is it true?

    By Michael C. Thomsett,

    • 0 comments
    • 1,393 views
  • Defining the Anchor Strategy

    Lorintine Capital and Steady Options have been trading the Anchor strategy for a number of years. During this time Anchor has evolved as we have learned more, in no short part due to the Steady Option’s members continuing questioning of the strategy, insights they provide, and a large group of individuals seeking to improve the strategy’s efficiency. 

    By cwelsh,

    • 0 comments
    • 784 views
  • The Life Of An Options Contract

    You may be asking yourself why am I reading this basic article about options trading? Well, if you’re anything like me, I didn’t learn options trading via the fundamentals.  Rather, I found a few strategies that made sense to me and started trading, without much regard to the underlying workings and details.

    By Drew Hilleshiem,

    • 1 comment
    • 2,902 views
  • Volatility Trends in the DJIA

    Options traders focus, often too much, on implied volatility to estimate the next change in option valuation. Is this always a wise policy? Options are derived from volatility in the underlying security (thus the term derivatives), a good question is: Why not focus on volatility trends in the underlying (historical volatility) to judge likely future valuation trends in options?

    By Michael C. Thomsett,

    • 0 comments
    • 1,672 views

  Report Article

We want to hear from you!


There are no comments to display.



Your content will need to be approved by a moderator

Guest
You are commenting as a guest. If you have an account, please sign in.
Add a comment...

×   Pasted as rich text.   Paste as plain text instead

  Only 75 emoticons maximum are allowed.

×   Your link has been automatically embedded.   Display as a link instead

×   Your previous content has been restored.   Clear editor

×   You cannot paste images directly. Upload or insert images from URL.

Loading...

Options Trading Blogs