Q and A. What’s Appropriate For My Account Size?

Hi Mark,
  

One of
the things I honestly love is the attention you pay to money management and am interested in seeing you discuss
controlling risk based on account size.  For instance, a trader with a10k
account probably shouldn't be in a 10-lot of RUT iron condors. Similarly, a
trader with a 50k account probably shouldn't be in 25-lot of SPX
iron condors – simply because too much of the account value would be at stake.

My question is what size is appropriate for the size of the
account?  Is there a certain tool or % you use to determine risk? I
know this is a little tricky because not everyone's account is the same,
and some are more aggressive than others.  But one of your goals in the
4 rules is to not going broke – because if you go broke you're out. Thankfully
I never have blown out my account but, I would just like to make sure I
am taking appropriate risks.

Sometimes I feel I am too conservative and
this has hurt returns.  Likewise it has protected me, but I feel I could take on more risk. Do you have any thoughts or
suggestions or could you do a blog article about this maybe ? Thanks
for all your hard work!

da

Hello da,

This is a serious topic and very appropriate for our times.

1) No one should place 100% of an account value at risk, but that statement is an oversimplification.  If that 10k account holder has $ one million invested elsewhere –
then I see no problem with risking every penny of that 10k account.  For that investor, the 10k account is probably the equivalent of a practice account in which a new strategy is being tested.  But, I do understand the point you are making.

A 10-lot of 10-point iron condors can lose up to $10,000, less the premium collected.  I agree that such a position is too large for an account that size. 

On the other hand, many investors and traders believe that it's a bad idea to risk more than 2-5% of the account value on any single trade.  Following that guideline conservatively, a 1-lot would be the limit in a 10k account.  If the position must be exited when the $200 maximum loss occurs, then the choice of options to sell becomes very limited.  The possibility of a $200 loss would have to become so small that it wouldn't pay to own the position.  My conclusion is that such a conservative 'maximum 2% of account value loss' is not compatible with 10-point iron condors when the account size is so small.  The compromise must be more cash, or less restrictive rules.

The point is that it's wrong to place the whole account at risk, but if one limits losses to a specified small amount, it may not be feasible to trade.  I would argue that the $200 loss is too conservative for many option trades, and others could reasonably argue that it's the $10,000 account size that represents the problem.

2) I don't use any tool to establish a maximum risk – at least not in the way you mean it.  Right now I am using Reg T margin and it's
easy to see the maximum possible loss for any open position.  Thus, if I have
100k, I know I can open 100 10-point ICs (I can use some cash premium collected to open additional spreads).  With that information, I know how many I am willing
to hold at one time.

When I choose to invest cash to buy insurance, I use the Greeks to help me determine 'how bad it can get today,' and that gives me a good idea of how many iron condors to hold.

I cannot recommend a rule of thumb for
others because so much additional information is needed.   For example, outside wealth plays a role.  Age and
the ability to recover from losses.  Income and job security.  Total household income.
  Additional obligations such as child support or caring for an aging
parent.  They
all play a role in determining how conservative or risky an investor
can be.  The more obligations, the less risk one should take.  And
none of this considers the comfort zone of the individual investor.

288

2 Responses to Q and A. What’s Appropriate For My Account Size?

  1. Joe S. 04/01/2009 at 9:16 PM #

    Hi Mark,
    I was wondering if you had any advice on targeting lower priced stocks which are still excellent fundamental plays in order to accumulate enough shares to begin selling covered calls. Is there a way to screen for stocks that could be priced in the high single digits or low teens that would be worth investing in for the ability to sell the covered calls? Are lower priced speculative growth stocks worth looking into for the purpose of selling the covered calls?
    Thanks!

  2. Mark Wolfinger 04/01/2009 at 10:11 PM #

    Hello Joe,
    I have no good reply for you, but do have one piece of advice.
    1) Lower priced speculative growth stocks are ONLY (repeat ONLY) worth looking into if YOU want to own some. I have no idea of whether such investments are appropriate for you.
    2) Stock screening tools exist and you can use them. But, you cannot screen for ‘stocks worth investing in.’ You set your own parameters and then search. Perhaps you require a minimum rate of year over year earnings growth. Or revenue growth. Or profit margin growth. I don’t know which factors are important to you and thus, cannot tell you how or where to search. I do know that search tools are available. Use Google and I’m sure you will find something suitable.
    3) I gather that you need low priced stocks because you are beginning with a small amount of capital. There is nothing special about low priced stocks. I believe it’s important that you buy stocks that you truly want to own and not just stocks you can afford to buy in 100-share increments.
    Here’s the best advice I can give you: Writing covered calls is a good strategy, but stock selection is FAR more important to your long-term success. Buy stocks you want to own and ignore the other stocks.