Position Size: A Matter of Life and Death (for a Trader)


This is
what I've been considering (Conversation started earlier). I figure the kites provide great protection
if the Iron Condors don't behave, yet they reduce the premium of an IC
significantly.  The risk is minimal but so is the profit.

So if I exited both the kite and the 10-lot of Iron Condors at the same time – for say
only $300 profit, it wouldn't be enough for me. However, if I put on 10
times as many I would have approx $3000 profit ,which is more acceptable. Thoughts?



You may be too young to remember Lost in Space, a TV show from the mid-1960s, but one line from that show comes to mind:


1) It requires 10k margin to do a 10-lot (of 10-point iron condors).

It requires 100k of available margin to increase size by 10 times and trade a 100-lot.

If you earn $300 when risking $10,000 that is no different from earning $3,000 when risking $100,000.

2) The risk graph looks nicer.  And it is nicer.  Perhaps it's 'nicer' by enough for you to move from 10 to 12 iron condors.  But to move to 100?  No way.

It is not that safe.  It is just safer.  And the final safety is going to depend on skills as a risk manager.  Do you have enough confidence in those skills to up position size by an order of magnitude?

3) I  hope that you are suggesting, or at least asking about, increasing position size by a factor of 10 because you are new to the options world. 

I would tremble at the thought of an experienced trader asking this question.

Increasing position size by anything except a small increment is fraught with danger.  First, you don't know how you will react if and when trouble looms.  Second, you may be risking almost your entire account on a single trade.  You just cannot do that and expect to survive. 

It's unlikely you would lose anything resembling the maximum 100k (yes, this is possible, depending on strikes chosen), but how can you afford to take that chance?  Would you be able to exit a trade to lock in a $20,000 loss if you judged the position too risky to hold?  If you cannot do that, you will become frozen and unable to take needed action.

4) Look at your risk graph the day prior to expiration.  Note how those kites have gone from a 'rescue plan' to a potential disaster.

I know you 'plan' to exit prior to expiration, but many times traders are just unwilling to pay the necessary cost to exit.

5) I agree that you may indeed do nicely with this concept.  But all it takes is one bad situation – guaranteed to occur (but who knows when?) and you may be permanently out of business.

Please do not do this.  If you get some practice with the 10-lots, and demonstrate a good ability to handle risk for a minimum of six months, then I would consider – and I mean consider (not automatically doing it), moving size up to where you buy two kites instead of one.  Under no circumstances can that be more than 20-lots of an IC, and I think that's too large of a jump in size.

One more point: When I said 'demonstrate ability to handle risk,' If you have six easy wins with no serious adjustment decisions, that does not count.  I am referring to situations in which you face serious decisions and make a good choice each time. I am referring to having the courage to do the right thing and not taking on too much risk just because you are frozen with indecision.  If you can do that a few times – then and only then can you consider yourself experienced enough to move up (gradually) in size.


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14 Responses to Position Size: A Matter of Life and Death (for a Trader)

  1. John 03/30/2010 at 8:13 AM #

    I am interested to see if you have any safety measures for IC to safeguard against a huge gap. For example, see 23/10/2009 AMZN.

  2. Mark Wolfinger 03/30/2010 at 8:22 AM #

    The best protection against a big gap is to simply own some extra options. Hopefully the cost is not prohibitive.
    Although I prefer not to own options that are farther OTM than my short option spreads, this is the exception: When you seek gap protection.
    If that’s undesirable, you may want to invest in because they include extra naked long options.
    Nothing else works as well as having unlimited protection. Second best is to trade reduced position size.

  3. Burt 03/30/2010 at 12:19 PM #

    Mark, you bring up an interesting point about increasing position size. You mention increasing to two kites with a max of 20 lot ics. But assume that you tend not to use kites to protect against excessive moves, and prefer exiting a position partially to reduce risk. By how much of an increment would you recommend increasing your position size if you’re used to trading 10 lots? And once you’ve become comfortable with the new size, how frequently would you consider increasing size again and by how much? This assumes limited capital constraints — within reason of course.

  4. Mark Wolfinger 03/30/2010 at 1:17 PM #

    Thanks or the question.
    Reply in a full post tomorrow.

  5. Burt 03/30/2010 at 2:02 PM #

    Great! Look forward to it.

  6. Joe 03/30/2010 at 2:51 PM #

    Thanks for making my original query/quetion into a blog post. You spoke about possible danger and not to increase size so much yet mention kites as owning unlimmited protection. I am little confused now as I thought if i have been successful at managing a portfolio of ICs of much greater size, than adding kites to each of those 10 lots would be very conservative and be considered almost prudent.
    I was under the impression that kites were a way of mitigating risk, are you saying adding those kites to each seperate 10 lot position is dangerous?
    Thanks, Joe.

  7. Mark Wolfinger 03/30/2010 at 4:37 PM #

    1) When you own an extra put or call, as with a kite, there is no limit to the potential profit. Thus, ‘unlimited.’ One call is worth a fortune if RUT rises to 6500. Similarly, one put is worth a bunch of dollars if RUT drops to 36.
    That’s all I mean by the term ‘unlimited.’
    2) If you have been trading iron condors in ‘much greater size’ I would have no way to know that. When you ask me about a 10-lot position and then talk about increasing size, my reply must be based on the assumption that 10-lots is your current normal position size. How could I assume otherwise?
    See tomorrow’s (3/31/2010) blog post for more on position sizing.
    3) ‘Almost’ prudent is a good phrase. Kites do a wonderful job of providing insurance against large losses.
    BUT – if you are someone who would hold the kited iron condors all the way through expiration, then it’s no a longer prudent trade strategy. Yes, it becomes risky.
    All you have to do to see that is to compare the risk graph today to that when it’s Thursday, one day before the settlement price is determined.
    4) So if you, the trader are not careful, and imprudently hold through the end – then yes, kites are not going to serve you well. They will do little to prevent the maximum possible loss from occurring. But once again, that is ONLY if you hold through expiration.
    On the other hand, if you prudently add kites to your portfolio and prudently exit prior to expiration, they should serve you well.
    Bottom line: What’s your plan?
    Exit early = kites are good.
    Hold through the end = kites are far less useful
    It’s all about your plan. It has nothing to do with the viability of adding kites.

  8. Joe 03/30/2010 at 4:59 PM #

    Thanks for the clarification. My plan is to continue managing my ICs as I usually would and exit my ICs and kites early in order to take smaller profits on many positions.
    BTW: This is all theory at present as I have previously added kites to my ICs at varied times but never set up kites at the same time as opening IC positions, so I will have to wait and see how I fair.

  9. 5teve 03/30/2010 at 5:38 PM #

    Hi, Mark
    If I used kite spread as protection for an iron condor,is it ok that the spread part of kite overlap with original IC spread? Is it still good protection? Another question is that if I owned 10 lot IC, to protect with kite, how many kite do I need to fully protect the original IC? Thanks

  10. Mark Wolfinger 03/30/2010 at 8:17 PM #

    1) You can use any strike prices you prefer. I often choose to make the kite sail (the spreads) overlap the iron condor short spread.
    2) Yes, it is still good protection – obviously depending on the price of the underlying.
    The kite never loses money – other than the original cost. To achieve that, there is a price range over which it affords little to zero protection. When overlapping, the area of zero help coincides with the maximum loss for the iron condor. Thus, there are better strikes to choose, but I often overlap the call spreads.
    3)’Fully protect’? What does that mean? It means different things to different traders.
    a) Do you mean guarantee zero loss at every conceivable price for the underlying asset at expiration? You know that’s impossible.
    b) Do you mean – as of the moment you open the kite spread, and for the remainder of that trading day – money cannot be lost if the current market trend continues? Well, excluding the effect of implied volatility, you can achieve that.
    But it’s temporary ‘full protection.’ Risk gets worse every day, and the protection erodes as expiration nears.
    c) Do you mean that if the underlying moves by a kajillion points, are you protected against loss? The answer is yes. Huge moves will fully protect the position.

  11. John 03/31/2010 at 8:41 AM #

    I think kite spread is a good idea, but a big gap, like the one I highlighted, is still very damaging despite having the kite spread. Of course trading smaller size will help, but that will result in smaller profit too.
    I have another idea, not sure about its feasibility, but maybe you can share some insights. How about buying a straddle at the end of the session, then sell it back next day when market opens. Transaction fee may be an issue here if I do this everyday, but let’s assume I only do this when I think something big might happen, like earnings report.

  12. Mark Wolfinger 03/31/2010 at 9:18 AM #

    You bring up enough points that I prefer to provide a complete reply. See tomorrow’s post.
    For right now:
    1)Gap is a winner for you, not a loser.
    2) Small size is a risk management tool. Underused, in my opinion.
    3) Too many costs to be viable

  13. 5teve 03/31/2010 at 9:18 AM #

    Thanks for fast answer. It is helpful. I mean what is the ratio between size of kite and original IC in order to protect from loss? or how many kite is enough for a certain lot of IC? Thanks a lot.^-^

  14. Mark Wolfinger 03/31/2010 at 9:35 AM #

    I understand the question, but I am unable to help.
    To protect from loss? When? The kite loses its effectiveness as time passes. If you plan to hold through expiration, there is no answer. Why? because you will probably do poorly when owning kites held through expiration, unless the underlying asset moves far enough to that your string option (the long option in the kite) is very deep ITM and earns enough to offset losses from the iron condor.
    The longer you hold the trade, the farther ITM the string must move to provide protection – by your definition of the word.
    Bottom line: There is no way that buying kite spreads can guarantee there will be no loss.
    a) If you buy ‘many’ kites, then the cost becomes prohibitive and a market reversal will kill your position.
    If you buy both call and put kites in quantity, then the cost is just too high. I would say don’t bother with the iron condor if the kites become the major portion of your portfolio.
    b) If you hold kites too long, they lose effectiveness. This is the point that (I believe) you are missing. Enough protection ‘today’ is not going to be enough protection in a few days.
    c) When you say a ‘certain lot of IC’ you can be speaking of one-point wide SPY spreads or 50-point wide SPX spreads. There is just no single reply to the question of how many kites are ‘needed.’
    Don’t forget that the strike prices for the kite make a difference.
    The type of kite makes a difference (C3 vs C4 etc)
    d) This is not a rote strategy. You (5teve) must look at YOUR risk graph today, next week, and just prior to expiration and decide if this is the position you want to own.
    Trading kites is a bit more complicated than I envisioned. The negative theta is the opposite of what you wanted when buying iron condors. that complicates matters.
    One thing is certain: If you own a position with the potential to earn a profit, there must be some risk of loss. If not, then the entire investment world would own this position.