Size Really Does Matter

Mark,

I use a position size calculator that I made in Excel. It tells me how many contracts I can trade, keeping always the max possible loss constant (in this case $6000 per trade).

As far as your comment about making an adjustment that increases the number of contracts from 40 to 60 is not quite clear to me. I mean, suppose that I do not have to adjust and instead, I want to add a second trade in my portfolio. If I buy an IC with the same premium as the first one (ie 0.50 for a 2-point SPY iron condor), using the size calculator, I will buy again 40 contracts. So, I will have in total 80 contracts in this case.

When you own two 40-lot iron condors, you may have established the maximum risk at $6,000 for each trade, and you may have an initial margin requirment of $8,000 ($200 margin per 2-point iron condor) for each trade, but the type of adjustment that you suggested (cover a portion of the short call spreads and sell a larger quantity of farther OTM call spreads) increases both margin and maximum risk.

This is also true when you adjust a 40-lot trade to a 60-lot trade.   Your maximum loss becomes MUCH larger.

As long as this is a paper-trading account, I recommend that you trade some 4-lots of 20-point SPX spreads instead of always choosing 40-lot SPY trades.  Learn how it feels to trade the bigger index.  Adjustments may be more difficult, but you save a lot of commission dollars.

 

 I started my paper trade portfolio with $200,000. Then I said that I will allocate 30% ($60,000) of the total portfolio for trading options (90 day iron condors). I will risk 10% of that allocation ($6000) for each trade.

If $60,000 is the amount allocated to trading iron condors, then there is no reason to have $200,000 in that account.  It requires massive discipline to not exceed that $60,000 limit when you either find an outstanding opportunity, or more likely, run into trouble and require more margin. 

Worse yet, a nice little winning streak can boost confidence and result in your trading 60-lots instead of 40-lots.  The problem is not with having a winning streak. The problem is that winning steaks tend to result in traders increasing risk and trade size by too much, and far sooner than is prudent.  When you have extra cash available, it's tempting to use it.

Keeping that $140,000 in a separate account – so that you must manually make a transfer to get your hands on that capital, is a nice safety play.  The cash is there if you truly want to use it, but it cannot be accessed without making a direct decision to do so.

When the premium is higher I trade more contracts, when the premium is lower I trade fewer contracts – but the max risk is always the same ($6000).

You may want to reconsider.  Just because the premium is $0.52 instead of $0.50, it does not mean that you must push the envelope and trade 41-lots.  This is still true when you collect an even higher premium.  You are very new at this game, and you are looking at far too many variables at one time.  Learn now.  Save refinements for when you know enough to make educated decisions.

I will make two trades each month.  Therefore I will own no more than 6 positions at any one time, w/o counting adjustments, in my total portfolio of 90 day iron condors.  I will risk max $6000 per trade or $36,000 for the whole portfolio.

Going back to your example (in your initial comment), when you buy (to close) 13 of your short call (or put) spreads and then sell 33 spreads that are farther OTM, the margin requiremnt has increased by 20 x $200, or $4,000. 

However, it's your maximum loss that is now out of kilter.  You can lose $150 each on your remaining 27-lot iron condor.  Plus, you can lose $180 x 33 ($5,940) on the new call spreads.  That places the max loss at $10,000 – not counting the loss already taken on the 13-lot. How does this adjustment maintain that $6,000 max loss requirement?  Making an adjustment does not release you from your limits.  Adjustments are made to reduce, not increase, risk.

Not only does this jeopardize the safety of your account) because it's likely that you will want to adjust more than one position at the same time – or almost at the same time, and you do not have the experience to make a judgement about whether that risk increase is justifiable (as a special situation) or whether it's so risky that you should never make this trade.  Not if you want to pretend that you are paying any attention to managing risk.

Please understand.  If you want to trade this way, if you are willing to take on the added risk you do get something in return.  You do get the increased probability of earning a profit each month.  Plenty of amateur traders trade this exact, higher risk path.  Even some professional traders may adopt this adjusment method.

However, they know when to do it and when not to do so.  They have a firm grasp on risk management and know when it's reasonable to add to risk and when it is verboten.  As a paper-trader with zero experience, you cannot expect to learn enough (in however many months you dedicate to paper trading) to have a very frim grasp on risk management when using real money.

For your safety and sanity, I suggest that this plan is not viable.  Not now.  Not without much more experience and knowing how skilled you are when it comes to making difficult trade decisions.  I'm excited for you that you have a plan, are thinking through the possibilities, are asking questions.  That's all good.  But I believe you fail to see the risk involved with the methodology suggested.

This leaves me with another $24,000 available for adjustments.

Good.  A very reasonable sum.  It should be enough, but not if you use large chunks of that extra margin every time an adjustment is made.  Be careful not to stretch the limits – because if you are thinking of going all in with that margin, it's likely that your risk is going to be far higher than your 'maximum.'

Does this make sense? Again, thank you very much for your support.

Yes.  It makes sense.  But not for you.  This is not the path to learning the importance of risk management.

Dimitris

***

This question, and part of the reply has already been published as a recent comment and answer.  However, many readers see Options for Rookies only through an RSS feed, and the comments are not avaiable through that source.

This post is important to traders who routinely adjust positions by increasing position size.

Size matters.  Size kills.  Traders who are capable of handling moderate risk can easily panic when positon size becomes too large and gigantic losses (gigantic for the specific trader) loom.  Please be careful.  Managing money and limiting risk are essential skills for every successful trader.

810



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