Bill Poulos: Options Trading Risk Management

Bill Poulos offers advice on options trading risk management:

My name is Bill Poulos. I started studying the markets back in 1974. Here it is, over 40 years later, and I’m still trading.

Over the last 4 decades, I’ve figured out some important points and learned some hard lessons when it comes to making money in the markets.

Without further ado, here is the single most important piece of options trading risk management advice I can give to anyone who wants to start trading the markets…

“Never, ever, ever, ever, risk more than ‘X’ on a single trade.”

It sounds simple, but it’s probably the single biggest mistake I see traders make over and over again. Most people never expect to lose. But the law of probabilities states that, not only will you have losing trades, there’s a very real possibility you could lose five trades…IN A ROW!

The average person who loses 5 trades in a row will see their account completely wiped out. But if you follow my #1 piece of advice, you can avoid crippling losses and keep your account balance sitting pretty, even if you hit a rough patch and end up losing 5 trades in a row.

Luckily, you don’t have to guess. You can use my options trading risk management calculator to figure out exactly how much you can risk on your next trade.

Profits Run Options Trading Risk Management Calculator

Here’s an options trading risk management calculator you can use right now to figure out optimal position sizing for your portfolio. Go ahead and play around with it.

And here’s how it works…

First, start with your account size.
For example, let’s say it’s $10,000.

Next, plug in the maximum percent of your entire account you’re going to risk. If your account is less than $5,000, risk no more than 5%. If your account is greater than $5,000, risk no more than 2%.

So, in this example, we’d use 2% of $10,000, or $500. This is the maximum amount that you are willing to lose if the trade is a loser.

This doesn’t mean that you would only spend $500 of your account but it does mean that you would have no more than $500 at risk.

For purposes of this example, let’s say the planned purchase price of the option that you want to buy is $200, and you plan on putting your protective stop order at 50% of the option premium or $100. This means that if the option price dropped to $100, your position would automatically be sold with just a $100 loss per option ($200 minus $100).

So you’d plug in $100 in the “Planned risk per contract” field of the formula, and then divide your $500 planned risk by $100, to get the maximum number of options you should trade, which would be 5 in this example.

If your entry price is $200 and you can buy 5 options, you’d be putting $1,000 into this trade but because you have a protective stop order set at $100, your maximum loss would be only $500.

That is a very powerful concept that eludes most people. And if you do nothing else but apply this one concept, you’ll be positioned to totally avoid the account-crippling losses that wipe out most traders during big market crashes.