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Options Risk - A Quick Lesson

To start - this is based on LONG options strategies only (buying them and ideally selling them at a higher price with underlying favorable movemnt).

It also primarly focuses on shorter-term moves (< 2 weeks).

Many a new (and seasoned) traders have sucommed to the lure of "making a big score" trading options. There is nothing wrong with this at face value, because if you trade options long enough, and are comitted to your process, it will happen. Over time it should happen more and more frequently. And by 'making big score' I mean on your account as whole, not an individual trade per se...although one trade properly sized with an outsized move can do it too.

The most common question I hear is "how much should I risk per trade?". Well, that depends on a few factors, too many to cover them all, but here are a few key ones:

  • How many other trades do you have on in the same direction?

  • Do you have any other trades on that may 'offest' them if wrong?

  • What are the statistical metrics of your system/strategy? And if you are working with a data sample less than 100 (1000+ to be honest), it's not statistical edge. And don't just focus on win rate, profit factor can trump that.

  • Is there any news or econ events looming?

  • Before placing the trade do you know at what point(s) you will exit? - either on the options % gain themselves or underlying movement

  • Last but not least - are you okay if every position you have on goes to ZERO? What impact (-%) will that have on your account as a whole?

If you can't answer ALL of these questions with clarity, figure that part out. However, a few decent concepts to start with (not advice):

  • Take a dollar amount and assume you put that equal amount on 25 trades in a row and they all go to zero. If the sum of those losses would not make you want to jump off a bridge, it's likely a good starting point.

  • Start with risking a mere 0.5% to 1% per trade of your total options account value. Or trading capital, risk capital or whatever you may call it.

Be careful out there....


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