thinkMoney - Summer 2019 - 44

July 2019

In this issue:

  • The Utility Player: How Big Should My Options Trade Be?
  • Pairs Trading: The Third Dimension of Trading
  • Vega: Its Not the Number You're Thinking
  • All In the Ratio: Fundamental Analysis for Futures

 

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Size Matters

•YOU’VE HEARD IT all before:Trade small. Don’t expose yourself to too much risk. Diversify. And so on. In poker, your bet size isn’t likely to be the same for each hand you play. And as you continue to play, your strategy changes depending on the probability of winning the hand. The same goesfor position sizing your options trades. You know the size of your trading account. How much of that are you willing to risk on one trade?


It’s a question that’s easier to ponder than answer. What works for one trade or trader may not work for another. Sometimes you may use a certain percentage of your account size, while other times you may look at max loss. If you spread your funds across one or two trades, it could whittle down your account and blow it out. Maybe you had a bunch of great trades and your account has doubled in size. Do you double the risk per trade now?


In a word, position size matters— now and in the future as conditions, and your net trading capital, change. Yet, we often don’t look at it holistically enough. In “How Big Should My Options Trade Be?” on page 16, you’ll learn how you might gauge your risk Size Matters for your trading account and your portfolio from the perspective of utility. Are you ready to up your risk and put on a larger position, or do market conditions dictate that you dial back your position size? It depends on a lot of variables—market trend, width of bid/ask spreads, volatility, and so on.


Once you place a trade, whatever goes into making a decision, it helps to have some tools to let you know what could happen to options prices when things change—the direction of the underlying, time marching on, and volatility rising, for example. The “greeks”—delta, gamma, theta, vega—are such tools. In part 2 of our greek saga on page 24, we’ll cover vega and show you a few things you might not already know about this volatility soothsayer.


The sky’s the limit when it comes to the number of ways you can adjust and manage an options position. So keep it simple and consider using the principles of utility and greeks to help with entries and exits. When things change, you’ll be better prepared to act on your trading plan instead of reacting to unexpected surprises.


Happy trading,
Kevin Lund
Editor-in-Chief, thinkMoney