Money Management For Options Traders
Money management when trading options has different principles from those you would use when trading stocks, and is one of the most important aspects of any type of trading. If your money management is poor, you are effectively blowing a hole in the waterline of your investment ship – you will inevitably sink. It is this single factor that traps most traders, and it is even more critical when trading options, because you can stand to lose 100% of your investment if you have a trade going wrong.
Your goal as a trader is to make sure that you don’t lose money, or to ensure that the losses you take are limited and controlled. Take charge of not losing money, and you will find gaining profits that much easier.
Most stock traders work on the 2% rule, which means that you will risk up to 2% of your capital on a single trade. So, if you have a base capital of $ 25,000 your maximum risk at one trade will be $ 500.
This does not always mean that you will only buy $ 500 worth of stock in each trade, but that you will RISK this amount.
For example, if you enter a stock trade with a stock price of $ 25, you would typically set a 4% stop loss, which you would set at $ 24. This means that you are risking $ 1. If capital is $ 25,000, and your maximum risk is $ 500, this means that you could buy up to 500 shares of the stock, which is a total trade of $ 12,500. Looking at it like this, this would mean that you are effectively limited to a maximum of two open trades at any one time.
This rule works for stock trading, but the principles are different when you are trading options. For example:
When trading DITM Calls and Puts:
