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Controlling Risk in Options Trading

Posted by Pete Stolcers on December 24, 2009

Option Trading Question

How can I mitigate the risk as much as possible when I trade options?

Option Trading Answer

Even with an options trading strategy that is profitable most of the time, you will still find that you will experience losses, sometimes several in a row. When you experience several losses, it’s easy to have a knee jerk reaction and overreact which can put you and your money in danger. You have to be careful how you handle it so that you can control the risk of losing money as much as possible. As a short term options trader, you will be trading a lot and you will find that strings of losses come along fairly regularly. Another thing that can happen is when you hold a position overnight; you may occasionally find leads to large gaps down in response to bad news. Both of these can put you at risk and you need to learn how to minimize it as much as possible.

The best way to minimize your risk during options trading is to control your trade size. When you find a successful trading strategy, you should stick with it, but always remember that you want to keep your risk down as much as possible. A good options trader will diversify through the number of shares in a trade. It is best if you divide your account into 10-15 trades so that you don`t have all of your eggs in one basket, so to speak.

It is far more important for you to control your risk around a positive return than to think too big and go for a big win. The more you go for the big win, the more likely you will end up with a big loss which is what you should be avoiding in option trading. No matter what your options trading strategy, put your focus onto diversifying and finding ways to reduce your risk and increase your overall wins. After all, that is why you got into options trading in the first place.

Option Trading Comments

  • On 03/17, nicole said:

    I am new to spreads.
    I purchased an AAPL April call for 315 and
    sold an AAPL April call for 325.  Net Debit 1.70.

    Now I’m nervous with AAPL’s movement.
    IF I want to close it out, please explain:
    what the net credit (using the multileg option screen) means. It is currently 6.40-8.05.

    (My boyfriend was training me in options and we broke up so I feel stranded.)

    Thanks so much !
    Nicole Young

  • On 03/17, Pete Stolcers said:

    Your boyfriend is a loser for breaking up with you, but he did put you into a nice trade.

    To unwind the position you need to sell the April $315 calls to close and buy the April $325 calls to close. This will be done for a net credit. It looks like you should be able to get $7 given the current bid/ask.

    The options are deep in the money with the stock at $338 and I suspect you put the position on long ago.

    You will have a nice profit on this trade.

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