A Consideration for Trade and Risk Management

Tom Gentile

Posted in

By: Tom Gentile
January 5th, 2024

3 mins read

Welcome to 2024!

As we embark on a fresh year of options trading one of the things its important I teach is Risk/Trade management.

I am sure everyone wants to rush in to a new option strategy that they expect to make them tons of money. And if they don’t learn a new strategy they want to learn as many new strategies as they can.

While that may be exciting for new options traders and make things fresh for those who have been trading for a while, it is only one aspect of being an options trader.

Just as important as learning strategy or strategies and trying to execute those is a component of options trading and that is managing risk.

This article is going to provide you a style or approach to risk and trade management that I strongly encourage you to consider and even discuss with your broker(s).  It is called Cost as Risk.

Cost as Risk

Here is a consideration for you on how to manage your options trading Risk / Reward on a per trade basis.

Using stop losses is a means to manage your trades you may have already been taught.

There are actually two ways we see one can go about a stop loss.

  1. Use a percentage or dollar value stop loss or 
  2. Use one’s Cost of the trade as the trades Risk (Cost as Risk)

My team and I teach and use case studies based on a theoretical $25K account in which no more than 2% is at risk on any given trade, meaning no more than $500 risk per trade.

Stop Loss Percentage: If you go with a 50% stop loss rule that means one can set up a trade that costs $1,000 and at a 50% stop one would lose $500 but keep the remaining $500 to live to trade with another day.

Concern is, well let me ask you. How many times have you stopped out at a 50% stop only to see the trade turn around and work? Frustrating, right?

There is such a thing as stop hunting where the stops are seen by market makers and they can go pick off a stop leaving you with a loss on the trade again, leaving the chance the security starts moving in the needed direction helping the option recover its losses and maybe eventually move it into a profitable situation.

Cost as Risk: How about spend only up to your acceptable max risk  or up to $500 on the trade to begin with. You will have less contracts and therefore less profit potential, but you will not have an arbitrary stop loss percentage potentially taking you too soon if you are willing to risk the full $500.

This way the market and your position’s underlying security can bounce around all it wants and unless its value reaches zero you can maintain the trade and stay in it a bit longer, giving it a chance to work out.

It keeps you from having to over-manage it and all its gyrations as well, so less stress in your trading is also a benefit.

Position-Sizing: If you max risk is $500 and the cost of the option is $.50, that would allow one to ‘Open’ two contracts, equaling $500 cost.

Go with the one that suits your personality best.

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Stock and options trading has large potential rewards, but also large potential risk.

You must be aware of the risks and be willing to accept them in order to invest in the stock and options market. Do not trade with money you cannot afford to lose.

This is neither an offer to buy/sell/ or recommend a particular stock or option.

Hypothetical or simulated performance results have certain inherent limitations. Unlike an actual performance record, simulated results do not represent actual trading. Also, since the trades have not been actually executed, the results may have under or overcompensated for the impact, if any, of certain market factors, such as lack of liquidity. Simulated trading programs in general are also subject to the fact that they are designed with hindsight.

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