My Story and Risk Management

I repeatedly write about the importance of risk management when trading options.  Believe me when I tell you that I understand how much most of you are tired of reading about it.  How can I know that?  Because I've been in your shoes.

I firmly believe that if you don't pay much attention to what can go wrong and how much can be lost from a single position (or your entire portfolio), chances are very good that you will encounter an unexpected market move that will take your breath (and cash) away.  If you survived the turmoils of 2008, congratulations. That builds confidence.  If you are making money month after month with nary a problem, that builds over-confidence.  Be alert.

One of the sad things about trying to help others become intelligent option traders is knowing what can happen when things go wrong.  I remember my early years as a CBOE market maker.  I found it very easy to make money.  But sadly, I found just as easy to see it all go away.

Close friends warned me that my positions were too big and that I was asking for trouble.  I was a constant visitor to my clearing firm's risk management office, but instead of heeding the warnings, I decided that I knew better.  I was making good money, wasn't I?  Surely I could take care of any problem before it overwhelmed me.

Risk Management

One day in 1984, one of the company vice president's took me aside and told me that my best friend and I were #1 and #2 on the list of risky accounts.  I laughed it off with a comment similar to:  'It's just a computer searching for impossible situations that could make a big loss is possible.  Forget it.'

To make a long story short, the clearing firm (First Options) unhappily allowed me to continue to carry the positions.  It was just a few days later that my account was in deficit.  I had lost it all.  The explosive rally of August 1984 had done me in.  I had been in trouble before, but nothing like this.  I had to mortgage my condominium.  I was frightened.

I dug in my heels, found trading capital, traded very conservatively and worked my way back.  When the mortgage was repaid; when First Options had received every penny; I was greatly relieved.  But that was an ordeal to remember. 

I was finally convinced, but not cured.  I still carried risk, but nothing similar to those early days on the trading floor.  What's so sad is that I see it clearly now.  There was more than enough money to be made and there was no need to remain naked short so many options.  Today, I'm cured.  No naked options for me (unless I want to buy a specific stock – which I probably will never want to do again), and all positions have limited risk.

That's the background.  That's the reason I stress risk management.  Just as I had to learn for myself, I'm sure some readers will find that they have to learn for themselves.  I certainly hope it's a very small number of traders.  I refused to listen to people whose business it was to understand risk and how to maintain it at a reasonable level.  I'm offering you the same opportunity I had:  to be made aware of risk before something terrible happens.  I hope I'm getting through to you.

Good trading.


11 Responses to My Story and Risk Management

  1. Nirmal 08/12/2009 at 8:56 AM #

    Hi Mark
    I find your blog so useful and full of sage info.
    Please tell me, do you use any Technical Analysis
    and Chart patterns.
    Are these useful to reduce OPTION trading?

  2. Tyler 08/12/2009 at 8:58 AM #

    Great Post Mark. Thanks for sharing-

  3. Mark Wolfinger 08/12/2009 at 9:24 AM #

    I use almost zero technical analysis.
    But it is useful in options trading. It’s always good to be aware of support and resistance points.
    If you are good with charts, it can help you time entries and perhaps take legs. I’m not good at that, so I avoid it.
    Thanks for comments. If you like this blog, please tell friends to visit.

  4. Mark Wolfinger 08/12/2009 at 9:25 AM #

    You are welcome.
    Today’s post is painful to share, but the truth is the truth and I had lots of trouble with risk issues in my earlier years.

  5. JB 08/12/2009 at 3:01 PM #

    Hi Mark,
    Thanks for this and all the posts. This one reminded me–
    A smart man learns from his mistakes. A wise man learns from the mistakes of others.
    All the best,

  6. s 08/12/2009 at 6:50 PM #

    I head your warnings and am a true believer that size kills. However, how do you continue to trade comfortably for a living from a risk perspective when you need large contract size to generate income. Do you trade large & buy up protection according to the size or do you trade smaller size on multiple positions and vehicles? Just trying to work out most effetive way to trade ICs for a living. Would value your opinion

  7. Mark Wolfinger 08/12/2009 at 8:36 PM #

    I do not trade large size because when things work well, that relatively small size generates enough income for me. Obviously, when things go awry, smaller size leads to smaller losses. I’m no longer greedy. A couple of years ago I carried about 400 IC at one time. Never again.
    I trade ONLY RUT. I find it much easier to manage the Greeks with a single vehicle.
    My guess is that you are much younger and want a much higher income. Unfortunately that requires more size. And there are losing months. Nothing can be done about that.
    I buy what protection I believe I need. I do not buy further OTM for protection. That’s not for me. I buy nearer to the money than my shorts.
    I don’t really have good advice for you regarding trading IC for a living except for this: When it works, the rewards are very large. I’ve had several months with profits near 20%. That’s pretty much a year’s worth of income for many. Stay in the game, minimize losses and you have two choices: when the good times come (for IC), you will collect; or find a more viable strategy for current markets. Sadly, I don’t know what that strategy might be.

  8. simon 08/13/2009 at 1:18 AM #

    Appreciate your humble opinion on size and completly understand where you are comming from. Thats some large size you were playing with. I’ve been teetering with the notion of trading in larger contract size(30 lots)on 2 vehicles with protection appropriate for the adjusted size, as opposed to my usual 10 lots across 6 vehicles. Both strategies have their pros & cons in relation to diverification and risk management and whilst I am comfortable with a 10 lot I can’t help but think that concentrating on just 2 vehicles with greater size would be easier to manage. What are thoughts of others?

  9. Luis 08/13/2009 at 5:10 AM #

    Great Blog Mark,
    You said “No naked options for me”.
    Would you consider selling a vertical spread a naked option (in a risk sense)?

  10. Mark Wolfinger 08/13/2009 at 7:32 AM #

    It’s a trade-off. Further diversification – which cannot hurt, although don’t know how much it helps -vs. ease of managing positions.

  11. Mark Wolfinger 08/13/2009 at 7:33 AM #

    Tell your friends!!
    A vertical spread is not naked. Naked is just selling a put without buying that further out of the monty put that limits losses.