Options trading potentially gives traders and investors bundled characteristics of flexibility, leverage, and strategy. Yet, while options trading offers some unique characteristics, it also introduces its own risks. At Moneyplantfx we believe that risk management is the foundation of consistent, sustainable success in options markets.
Whether you are a newbie trader, or a professional trader, having knowledge about how to manage risk is the first step to protecting your capital and making the right decisions. We’ve put together a useful overview of risk management that will help individuals manage their options trading with caution and confidence.
It is important to know the fundamental concepts to understand future, more complicated strategies, such as:
At Moneyplantfx, we ensure that our traders have the best education available to provide a solid foundation.
A common mistake in options trading is over risking on individual trades. Manage your exposure by only risking a small percentage (1-2%) of your overall capital on any trade. This will shield your portfolio from a series of losses and allow room for recovery.
Don’t put all your eggs in one basket! You can easily diversify your options positions by:
Diversifying will lessen systemic risk in your portfolio and keep your portfolio balanced. This is something we preach at Moneyplantfx.
Although options are more difficult to set stop-loss levels than stocks, it is very important to set a mental or automated stop loss. Simply, define the maximum loss you’re willing to take on a trade and stay disciplined to that level of loss. This effectively allows you to reduce potential losses from one single trade. Trading is all about managing losses, and you can’t remove risks, but you can manage risks.
Options give you leverage, which makes it possible to control large positions with limited capital. A great feature of options trading, but leverage works in both directions, even on profitable trades. Always evaluate how much leverage is in a trade- and adjust for it.
Markets may change drastically based on news (such as a new launch, earnings, economic reports, or international events). It is crucial to know what is happening with your underlying assets. Moneyplantfx gives a real-time view from our news desk as well as important updates to ensure our traders are not under-informed.
If there is one thing you should take away from options trading, it is that discipline is necessary. Fear or greed may ruin what could otherwise be a brilliant plan equity portfolio. Follow the rules of your trading plan and assess your trades with a level head versus an emotional one.
Every trade (winning trade or losing trade) is a lesson to be learned. Make yourself a trading journal, log your results, and analyze your options around decision-making. Improvement is embedded in the Moneyplantfx creed.
Options contracts lose value as they get closer to expiration—the concept of Theta applies here. If you are trading one, two, or even three-week options, this time decay can eat into your position quite rapidly. Please be aware of time when you enter trades and make adjustments if required.
If you believe you are about to incur a large loss, hedging might be your best or only option. Hedging could include using spreads or protective puts to limit your downside risk while keeping the upside potential. At Moneyplantfx we suggest you consider hedging as a way to protect your capital.
Never be invested completely. As a rule of thumb, leave some percentage of your portfolio in cash so that you can capitalize on new opportunities, and also serve as a buffer in case of a downturn in the markets.
Don’t overthink complex investment strategies unless you fully understand the concept. Simple strategies will contribute to better risk management. You can only apply a complex options strategy, such as Iron Condor, Iron Butterfly, or Calendar Spreads, when you are 100% confident in the mechanics and risk.
There is no such thing as taking all of the risk out of trading—it’s all about appropriately identifying and managing risk. At Moneyplantfx, we would like to reiterate that it is improper to consider traders successful when they haven’t lost money. Successful traders minimize losses and maximize opportunity.
By applying many of these principles of risk management, you will be able to:
At the end of the day, options trading isn’t for every type of investor. There is the potential of losing more than you initially invest. Therefore, it is imperative that you educate yourself and consult with a licensed Financial Advisor before trading options.
Trade Safe, Trade Smart with Moneyplantfx.