risk management

[prosserd]

hi,

please point me to a thread if this has been answered previously, I couldn't find it with a search

question is...

how do you size positions / manage risk with options?

i found with stocks it is easy because the only thing affecting the position value is the underlying - so you can pretty much say "my stop is here, so my position size is X and i'll lose 1% of equity if my stop is hit"

however with options you have delta, theta, vega, etc affecting the option price so you can't get out for a known loss like you can with standard stocks

say i only wanted to risk 1% of equity per trade, how would you handle the risk management side for both the buy and write side??

d.

 

[ptrjon]

trading options with strategies where you minimize risk is like going to a trailer park to avoid seeing plaid.

 

[MTE]

The way you manage risk/size positions when trading options is pretty much the same as when trading stocks. The benefit of options is that you can use limited risk strategies, which allow you to size the position in a such a way so that the maximum loss on a strategy corresponds to your desired loss (i.e. 1%) or you can set a stop loss at a certain option/spread price level.

 

[spindr0]

Quote from prosserd:

however with options you have delta, theta, vega, etc affecting the option price so you can't get out for a known loss like you can with standard stocks

The Greeks are derivatives. They don't affect price.

i found with stocks it is easy because the only thing affecting the position value is the underlying - so you can pretty much say "my stop is here, so my position size is X and i'll lose 1% of equity if my stop is hit"

It's the same thing with options. The only thing affecting the position value is the value of the option. Just set a $$ stop loss on the option position. Use combo orders where positions are more complex.

 

[JJacksET4]

prosserd,

Of course, with options there are many possibilities for what you can do.

You didn't really mention if you are referring mostly to day trading or longer term trading, but of course, even with stocks if you set a stop loss at 1%, you can lose more then that if it gaps after/before hours, etc.

What some traders do is only trade options with a certain % of an account, and only put a certain % into each trade. For example, if a person has a 100K account, they may allocate 10K for options trading - then if they put 10% into each trade, that would be $1,000 - each trade then would risk 1% of account equity. Of course, many option traders try to position bearish and bullish positions at the same time and often shorter and longer term - therefore, it would be unlikely if they had say 8 positions open that they would all lose 100% of the investment.

Also, some options positions may have more of a stop loss based on the position and not the stock price per se. For example if a person buys a long straddle for $800 for 6 months out, they may set a stop loss based on time - i.e. if there is currently a loss, sell after 3 months - you can get a pretty good estimate on what the straddle would be worth at that point - of course IV (vega) can change it somewhat.

Other traders may do things for example like setting a certain amount to close out a credit spread at - i.e. if they sell 125 SPYS and buy 130s they may close if SPY then hits 123, before losses would start to mount more - and/or they may roll the options up to the next month and say 128/133 spreads (just as an example).

While you may not be able to know exactly what the price of the option will be in the future, you can still use mental stops. For example, if you were bullish on a stock (XYZ) that was at $100 and you bought a 100 strike call for 6 months out for $1000, you could plan to close it if XYZ falls below $95 - it's true that you won't know exactly what the option will be worth at that point - it depends on the timing, the IV, etc. But a person can make a reasonable guess about how much a 100 call would then be worth at that point. You might close it to take your loss and move on. Remember that if you bought 100 shares, you would also be at a $500 dollar loss at this point.

It is really up to each person to decide what they feel comfortable with and how much risk to take. I do think with options, you actually have much better tools to manage risk then with stocks alone.

JJacksET4