Sizing a Trade
Jun 28, 2010

Sizing a Trade

It is often difficult for a new options trader to get a feel for how many options to trade.  Trading an appropriate number of contracts is important to your success because it is the easiest method used to manage risk.

If you own stock and want to write covered calls, the decision is fairly easy.  Investors tend to write one call for each 100 shares of stock owned.

When selling naked puts (a strategy we will be discussing), margin requirements often limit the number of contracts that can be sold.  It's best not to trade that maximum, but at least there is a reasonable limit on the quantity traded.

If you are inclined to buy options, the margin requirements are much less restrictive (all you need is the cash to pay for the options), and it may be difficult to know how many options to buy.

Here's why: 
  • New traders - stocks, options, commodities etc.- tend to be overly optimistic
  • Each stock or index offers a bunch of different options to trade, and several are low priced
  • New traders are attracted to those low priced options
  • Those new traders don't recognize that it's easy to lose 100% of an investment
  • Paying 'only' $200 for 10 call options priced at $20 apiece can appear to be a huge bargain.  However, if the trader's account is only $2,000, this trade represents 10% of the entire account value.  That's a big trade.  Risking 10% on a single trade is already taking too much risk.  However, trading before understanding how options work, the newbie frequently buys the wrong option.  To make matters worse, that options is seldom sold.  The result is a loss of the entire investment ($200 in this example)
Choosing which option to buy is not the subject of today s post, but the point is that a small sum may feel trivial - even when it represents a significant portion of the account.

The beginner should not be investing 10% of his/her account in any trade, let alone one as speculative as this one.  Trade small size - few contracts.  There is plenty of time to place larger trades after you learn more about options and feel confident in your ability to understand and manage the trade.

Mark D Wolfinger

Expiring Monthly: The Option Traders Journal