Tag Archives | trade size

How I Choose my Trades


First and foremost I want to wish you a very Merry Christmas. I also wish to thank you for your gift to us of the Options for Rookies website. It's helped me learn a lot, along with your O.F.R book. Especially the "lose the pride, take the loss early" lessons.

I would like to ask you to consider a segment that would talk about your thought process in choosing your trades. If possible, I'm curious how you choose your spread widths, lot size, and strikes and what products you trade in overall.

I've noticed before your protocol of striving for a $3.00 premium for IC's. Is that a one-lot price or the total value for numerous contracts? I currently do only paper trading in Paper Money on Think or Swim (6 months now in verticals and IC's)and I see a lot of loss-risk vs. reward on the p/l graph when I try to reach those levels.

I thank you for any help in this area and again wish you and yours the best.



Thanks or the good wishes. I'm having a very happy Chanukkah right now, and hope to enjoy Christmas as well.  Your request is a good one, but my technique is pretty simple and thus, don't on't know how useful it will be to others.

The $3.00 is a one-lot price. I find it much easier to follow discussions when trades are broken down into the lowest common denominator, and so that's the way I write.


Market Bias

When making trades, the first thing to consider is whether you want to take a neutral, bullish or bearish bias.  This part is simple for me.  I never know what to expect, so I always choose a market neutral stance. 



There are always several strategies that suit a trader's market expectations and it's a good idea to experiment with several and maintain anything that works for you as part of your trading arsenal.  I've come to favor iron condors, and use them most of the time.  This is something for each trader to decide for himself – especially when in the paper trading stage.

I'll shift to double diagonals if and when I expect market volatility to be higher over the shorter-term, or when I believe IV is 'low enough' that I do not want to trade short vega positions.  It's important to have a suitable strategy when seeking profits from an option position.  You cannot just go out and'do something' and hope it works.


If you have some market expectations – regardless of direction – it's important to choose an underlying that you believe will participate in that directional move.  Other considerations are ease of entering trades, width of bid/ask spreads, satisfaction with fills, ability to adjust when necessary.  Once again, lacking predictive powers, I use a broad-based index, and always trade Russell 2000 options (RUT).  That may not be a good idea for you, but it's how I do it.


Specific Iron Condors

I know this is the heart of your question

1) Spread width.  I hope that you understand that this is far less of a big deal than it appears to be.  I choose 10-point iron condors because I find them comfortable to trade.  It's as simple as that.

If you want to trade 20-point spreads, there is one thing that must be understood.  A 2o-point spread is exactly the same as trading two consecutive 10-point spreads.  Here is what I mean:

Selling the 480/500 call spread is exactly the same as selling:

The 480/490 call spread and then selling the 490/500 call spread.  There is nothing 'special' about the 20-point spread.  I consider it to be a compromise and would choose that any time I was not sure which position I preferred to have in my portfolio: The 480/490 or the 490/500.  By choosing the 480/500, I get to sell an equal quantity of each spread.

One major point is obvious, but must be made:  NEVER sell the 480/490 and then immediately sell the 490/500.  That foolishly spends twice as much in commissions and increases slippage (the cash lost when trading due to the fact that we must deal with bid/ask spreads).  Just open the 480/500 spread in a single trade.

However, if you have a position in the 480/490 call spread, there is no reason why you cannot trade the 490/500 call spread at a later time.  Perhaps it would be adding a new trade to your portfolio. Or it may be part of an adjustment.

2) Lot size

If I am ready to be fully invested right now, then I decide how much margin money to have tied up in this trade, and enter an order for the maximum size.

When doing that, I always reserve some margin room for future adjustments, if needed.  If you never use anywhere near your maximum available margin, this is not a consideration.

At other times, I'll enter a portion of my preferred trade size, to get started, and then try to do more an a better price.  So, for example, if I decide to allocate $20,000 of margin to a new February RUT iron condor, I would enter an order to trade 20-lots of my preferred iron condor.  I'd keep the cash generated (let's call it roughly $6,000) available for future adjustments.

Alternatively, I would enter an order to trade two different iron condors, 10-lots each.

Most of the time, I enter an order to trade 4-lots.  Then trying to get $0.05 more for a 6-lot.  Then I try to add the final 10-lot for yet another 5 cents better.  If I cannot get my better prices, I have two choices.  I can go back to my original trade price, find another iron condor, or just play smaller size that month.

I do not take too long to get as invested as I want to be.  Perhaps Monday thru Wednesday after expiration (I'll open March RUT positions once the December option cycle is over)


3) Premium (price) and strikes

Each trader has a primary method.  Either the strikes are more important or the premium is moe important.  For me it's the premium.

One good way to choose strikes is by standard deviations.  The trader sells spreads in which the short option is 1.0, 1.5, or any other number of standard deviations out of the money.  This does not work for me, but it truly is a viable method for selecting strike prices.  It has the advantage of keeping the probability of seeing the options expire worthless at the same level (at least on the day the trade is made) each time you open new positions.

I prefer to take in a certain cash premium for my 10-point, 13-week iron condors.  Note:  I am not insistent.  If I find that the strikes chosen don't feel right – because of a market bias (I may not want to be bullish or bearish, but that does not mean I must ignore those thoughts.  If I feel my chosen strikes are just not far enough out of the money, then I'll take less premium and move out one additional strike price).

My preferred price is $3.00.  I always seek higher prices when implied volatility is high and the price of credit spreads is higher.  I could move further OTM, but prefer to collect $3.30/$3.40.  This is fairly flexible.  When concerned with risk, I'll go farther OTM and collect nly $3.00.  My point in offering this much detail is to explain that this is very flexible for me.

When IV is low, and it is lower than it has been in a long time right now, I'll just take $2.60 or $2.70. I'd rather feel safer going into the trade.

I don't always open three-month iron condors.  If I believe IV is just too low to sell extra vega (3-months options have more vega than 2-month optioons), I'll sell those 8- or 9-week options instead.  I prefer to collect just over $2.20 for these trades.  Hwever, as you may anticipate, it's a flexible number.

If you trade a different underlying, they these prices would be meaningless to you because the implied volatility of the options would be very different.

4)  Products.  i do believe diversification is important when selling premium.  Thus, if trading individual stocks, I'd want to have about five positions open simultaneously.  Trading indexes, I feel that supplies sufficient diversification and there is no advantage (for me) in trading more than one product.  This is the main reason:  If trouble looms, if the markets get violent, I want to have the fewest possible posiitions to adjust.  One product ismuch easier to handle than two.  I may lose a bit to diversification safety, but I make up for than in having half as many troubled positions to handle when important decisions must be made.  True my trade plan helps with those decisions, but I prefer to depend on being able to 'see' what's available at the time when others may be in a panic.

5) Expiration months

I'm happiest with 13week iron condors.  But when IV is especially low, or I don't like the premium available from 3-month trades, I'dd choose 2-month positions instead.

I do not trade front-month options,except to exit any front-month positions that I still own.  I do this to avoid positions with so much negative gamma.  yes, I give up the rapid time decay, ut it's safer and I'm happier with less overall risk.  You may feel differently.  that's ok.  Most traders prefer to trade front-month options and love trading the Weeklys. (RUT has no Weeklys as of this writing).

Bob, I hope that gives you enough insight to allow you to find methods that are suitable for you.





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Options Trading: The Role of Luck

Bad Money Advice is a worthy blog.  Penned by "Francis X. Curmudgeon, the alter ego of a bitterly unemployed hedge fund manager in the suburbs of Boston, Massachusetts," the blog is designed to publicize the fact that so much bad advice is readily available that he feels the need to combat it.  In his words,

"the main topic here is the advice given by others and how bad it is. And
not just any advice. I mean to talk about advice on a single subject of
almost universal interest: money."

In a recent post, he discussed the role that luck has when investing.  Most traders have a great deal of confidence in their ability to outperform the markets, but the unsophisticated retail investor must play the cards dealt. 

"Consider somebody born in 1916 who turned 65 and retired in 1981. In
the 20 years before his retirement the stock market averaged a return of
only 6.57%, just 1.07% ahead of inflation over the same period.
$100,000 invested in the market on his 45th birthday would have been
worth $357,026 at 65.

Now consider someone born 17 years later, in 1933. Over the 20 years
before his retirement in 1998 the market averaged 17.32% a year. (That
happened to be its best 20 year period since 1890.) $100,000 invested on
the last day of 1978 would have grown to $2,440,288.

The difference between $357K and $2.4M is tremendous in terms of
retirement wealth and lifestyle. And yet all that separates these two
people is the year in which they were born. And those years are not even
that far apart. The 20 year investment periods actually overlap."

As traders, we don't rely on the cards dealt to us.  In fact, we are constantly reshuffling the deck.  Nevertheless, any time you deal with probability, statistics must be considered. 

Whether we buy or sell options, we undertake a trade that is based on probability.  Over the longer term, chances are high that statistical predictions will be validated and that a 70% probability event will occur roughly 700 times out of 1,000 events. [Reminder: unlikely events, or the tails of the probability distribution curve, appear far more frequently than predicted].  However, on a single trade, luck plays a role. Or as one definition of the term provided by Wikipedia:
"luck is probability taken personally."

Unless you want to depend on having good luck – a very poor investment strategy – it's important to take matters into your own hands.  That's why it's so smart to practice good money management (size trades properly) and good risk management (control losses). 

As regular readers know, risk management is a constantly recurring theme at Options for Rookies.  Unless you have very good luck, trading without a proper respect for risk, and constantly being aware of and managing risk, there is little chance you can succeed as a trader.  It's a difficult enough profession without taking more risk than is prudent.

Risk management is vital for survival – even when you trade/invest without being a professional.  I wonder if Francis X agrees.  I trust he does.


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The Role of Probability when Trading Iron Condors

Hi Mark:

Thanks for the posting. After reading so many reader's question, I am
curious about how you personally see this thing: The role of
probability in option trading.

Just as we discussed last time – the market return is actually a
"fat-left tail bell-shaped distribution" (Ok, similer to normal
distribution but not exactly). So, it means that, a "market direction
neutral" strategy is possible, given the probability distributions of
the broad market return have been relatively very similar across time.
Just by strict risk control, is "trading probability" an feasible way
to survive in the market???

Personally,even though I do see a lot in probabilities, the
"expected value" is never in my trading plan. I know too well that,
when, the tail risk happens,even if, I do spreads, and as long as I put
all of my eggs in one trade,then I am still a dead body — this has
nothing to do with "expected value". So my biggest plan is always
ex-ante risk control.

Thanks in advance if you can share your view on the "probability trading" way.




It's not just probability.  It's also about profit potential. 

You cannot evaluate whether to accept a specific probability of success without knowing how much can be earned.  That's why I try to find a compromise between going as far OTM as possible (HIGHEST probability), with a GOOD profit possibility (not too far OTM). 

No risk is worth taking, no probability of success is high enough when the reward is too small to justify the risk.

In short, I don't dwell on probability.  But that's because the option's delta already provides a good picture of probability (of a sold option expiring worthless) and I already took it into consideration when choosing my strike prices for an iron condor trade.

As you note, we do have a fat tail problem on the left (down) side of the curve.  I take care of that problem in one of two ways.  I can trade less size (my current method), or I can buy insurance (which I prefer, but I only do that when option prices feel reasonably priced).

I am content to trade less size and keep cash in reserve because it reduces stress and allows me to adjust a trade with less pressure (threatened loss is less).  Sure, the profits may be reduced, but that's the trade off.

As a side comment, this has been working well.  June and July were my two best months since I trading iron condors, and even with reduced profits, I am satisfied.  My results were far worse earlier in the year when I was trading more size.

Henry – if you are protected from being killed, that's a good thing.


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Risk Management and Position Size


Contest winner: An Options Tagline


Hi Mark,

How do you determine position size ? What can someone use to guide
them to determine lot size, contracts traded etc ?



Hi Dave,

Obviously, a good question and one that I never addressed.  I'll offer some guidelines and an example.  As you may suspect, this is a guide and not a method for deciding exactly how many contracts to trade.

1a) At the top of the list : The trader must be comfortable with the largest possible loss for each position.  If a position involves being naked short calls, then that 'maximum' must be estimated. 

This is just as true for premium buyers as for premium sellers.  Buyers cannot get wiped out overnight, but they do get wiped out by paying prices that are too high or holding positions too long.

1b) A more realistic reply is that the trader must be able to withstand the largest likely loss.  This is true not only for each position, but it must be true for the entire portfolio (this is the part many traders ignore).  If you have five positions and each passes the test, be certain that if all five were to move against you at the same time that you would survive.

1c) By 'survive' – I do not mean 'barely survive.'  It means that the loss from a single position can be shrugged off as the cost of doing business.  It also means that the drawdown from a total disaster (losing the maximum from all positions at once) does not eliminate your ability to continue trading.  Risk of ruin must not be ignored.

The above response does not answer your question

Here are more General Guidelines.

1) Determine how much money you want to devote to trading options.  If possible open a separate account to house that money.  If you do any covered call writing, then obviously this account must include your stock holdings.

If you keep your entire investing assets in a single account, then it is difficult to see how much margin is tied up with option positions.  When there is extra cash (or margin availability) lying around – it's tempting to use it.  Thus, a separate account (surely your broker will accommodate your request for a sub-account or a separate account) makes it much easier to track option P/L and risk.

2) If you do as suggested, then 100% of that account is devoted to options trading.

3) If you choose to accept portfolio margin (many brokers require 100k minimum for this) you have the room to trade many more contracts and much greater size.

If you choose (or must accept) Reg T margin, then you are more limited.  However, that's not a bad thing because you are ultimately safer.

In my opinion, Reg T margin is best for the vast majority.  If you have proven to yourself that you can handle larger positions, if you trust your risk management skills, then you can opt for portfolio margin – if eligible.  But please know this:  With Reg T margin, positions are limited and you cannot go into deficit. That is not true with portfolio margin.  Obviously your broker will limit risk because if your account goes into deficit, the broker is at risk that the customer will not be able to repay.

4) Never use all available Reg T margin.  Allow at least 15% for emergency needs – such as making adjustments that increase margin.  There's no room to discuss here, but not all risk-reducing trades decrease margin requirements.

5) Dave, if you have a small account, trade small.  With a $10,000 account, you don't want to trade more than three or four credit spreads, or iron condors at one time.  A loss of $2,000 would not put you out of business, but it would be a significant loss.  And it's easy to lose far more than that with a 4-lot, 10-point iron condor.

6) When you begin trading, it's not so easy to recognize an acceptable position size.  Paper trading can be very useful in this regard.  When you experience the profit and loss per spread, you can get a feel for what would be at stake when trading live.

7) Truths

  • Most
    people who begin trading are optimistic.  They do not think in terms of
    losses, but instead, concentrate only on how much money they can earn

  • It's virtually impossible to find a reasonable position size when the trader does not consider scenarios in which money is lost
  • If you accept the premise that limiting risk is essential to becoming a successful trader, then sizing trades is easier.  If neglecting risk, selecting position size is merely a guess

Assume you trade a specific strategy with limited losses.  Further assume that you have the discipline to exit the trade when your loss reaches a certain level.  This loss level does not have to be written in stone, but it's a reasonable approximation. 

If those assumptions are valid, then you can establish an appropriate position size. 

Next, decide the maximum dollar loss per trade. Assume your position goes awry and you
lose 10% above that maximum loss. 

That's it.  That tells you how many spreads you can afford to hold at one time.  Obviously of you find a trade situation that feels better than normal, you can increase size by a modest amount.  When markets are more uncomfortable for you to trade, enter with smaller size.  You can always add to a position later.


Assume: (Please recognize that approximations are made)

a) You, Dave, prefer to sell credit spreads.  Calls/puts or both (iron condors)

b) Your minimum premium requirement is to collect $1 for a 5-point spread. (20% of the maximum value)

c) Your account is valued at $100,000

d) You plan to carry at least 10 such positions at one time (that's a large number, but let's go there for now)

e) You are psychologically and financially able to accept a loss of $5,000 from any one position

f) You have the discipline to exit a trade (ignore adjustments for this discussion) when the loss is $150 per spread [This is a randomly chosen number; it is NOT a recommendation]

g) You must limit portfolio losses to $20k at all costs.  This is the bottom line for you.[Again, a random number]

Based on those assumptions, what can you trade?

If you trade a 5-lot of each, and if you only collect your minimum of $100 per spread, then you sell 50 spreads (5 x 10 positions) and collect $5,000.  If there are any iron condors in this portfolio, you collect an extra $100 for each of those (you collect on both puts and calls).  The maximum possible loss is $400 per spread, or $20,000.

And that's the worst case.  You plan to exit when losses reach $150 per spread,  If that happened to all 50-lots simultaneously, you would lose 50 x $150, or $7,500.  Allowing for a loss that's 10% above the maximum (poor execution of orders, or delay on your part), moves the loss to $8,200.

If some positions are calls and some are puts, you would not lose that much.  

Thus, it's reasonable to trade about 2.5 x as much, moving the maximum loss to that $20,000 level.  This is a very unlikely outcome and with this scenario, I'd suggest that you could afford to trade as many as 12 to 13-lots of ten different (5-point) credit spreads. 

We all know that that is too many positions to manage effectively,  but you can afford to trade a reasonable number of contracts.

If you trade only one position, you can trade the same 60-lots.  And if selling 10-point spreads at $200, then 30-lots should be okay.  Trading this much size would present no problems as far as margin is concerned. [Margin requirement is 30k, less cash collected, on 30, 10-point spreads).

Dave, this is approximate, but I don't know how to decide how much size is appropriate to trade without going through an exercise such as this.

'This above all, to thine own self be true."  That means – DO NOT move beyond your comfort zone.  Trading less size is just fine.  It's trading more than your  size limit that must be avoided.


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Success Breeds Failure. An Unexpected Result?

One of my interests is 'psychology of trading.'  It's a fascinating topic and understanding the basics (if there is such a thing) can truly help a trader perform better.  The difficulty with that is recognizing that any of these principles applies to you.  It's so easy to dismiss studies as being unrealistic.  If not unrealistic, then at least the average trader has many reasons why the study does not apply to him/her.

We all want to make more money when trading, but many times traders inadvertently sabotage themselves by making decisions that they sense are not in their best interests.  It's not deliberate.  There's no attempt to prove to anyone that you can do it better than others. 

It's often the result of being uninformed about the myriads of data that explains why some trading decisions are less likely to be successful than others.

One simple example is the size of one's trading account.  Many rookies put together a very small stake ($2,000 or less) and begin to trade.  The chances for success are just dismal.  As yesterday's post of the risk of ruin indicates, the less money you have to trade, the greater the chances of losing your entire trading account.  It's a statistical truth.  But, it's also ignored.


Recently I read a very interesting research study (actually a blog post that discussed that study).  It concerned why traders alter their behavior – depending on whether the most recent trade was a winner or loser.  It would never occur to me to alter trade size, and thus risk, on anything as flimsy as that.  However, when the sample being studied includes a large number of traders and a large number of trades, patterns emerge.

The blog was by the CXO Advisory Group. Much of what follows comes from their post,  The original paper is no longer available online. .

The 6-month study (2006) covered more than 1.3 million Indian investors and 111 million transactions worth $85 billion. The details are available in the CXO post and the paper, but the interesting points to me are: 

  • Investors lost $2.3 billion
  • Investors with positive past trades – trade more often
  • Trading
    volume is 7.7% higher for traders with recent gains than for those with losses
  • The probability of increased trading volume is 1.7%
    higher for an individual with recent gains
  • The sign (+ or -) of recent outcomes explains 89%  of the variation in
    subsequent trading frequency
  • On average, profitability of current trades is almost 60% lower for
    traders with recent gains rather than losses.
  • The more successful individual investors appear
    to be those less influenced by the signs of recent trades.

Bottom line: The sign (much more than size) of recent trades influences future trading behavior
of individual investors. This influence hurts overall

This is the typical situation that I find so interesting.  Something minor, such as a winning trade, influences some traders to make the next trade larger.  The real question is why the ensuing trade loses so much more often.

It may be the result of being anxious to trade again, resulting in a poor choice of trades.  It may be that overconfidence ruins risk management.  There's no way to discover the answer.  The takeaway from this discussion is that mindsets can be altered by seemingly minor events.  It's important to pay careful attention to your trading plan (if you have one) and make every effort to avoid allowing emotions to affect your decisions.


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