Sometimes it’s the little things that matter and make the difference between being profitable or not in your trading. We are going to discuss three key concepts of trade size that might not seem important but that can make the difference between success or failure. What are these three concepts?
Key Concept #1 is the importance of sizing. You will often hear us say, “trade small, trade often”. That’s because we want to have a high number of occurrences. The more occurrences we have the more our actual results will match our expected results. Let’s say you are using a strategy that our studies say has a win rate of 80%. The average win is $100 and the average loss is $200. Should you have two winning trades in a row at $100 each and decide to move your size from a 1 lot to a 3 lot you may be inviting failure. Should that third trade be the loser that occurs on average one out of every five times you’ll have a $600 loss. Returning to a 1 lot would mean two more $100 winners. Overall you would be down $200. Had you kept your trade size the same or kept to the 3 lot size after changing you would be up $200.
Key Concept # 2 is that the number of contracts traded can be adjusted to match desired risk levels. Should your risk level be $600 and you are trading a strategy in which you will take a loss at 2 times the credit received that means if the credit is 3.00 ($300) you should only trade one option but if the credit is 1.50 you should trade two options and if the credit is 1.00 you can trade three. Risking the same amount will produce more consistent results and if a strategy is profitable provide you the best chance of being profitable.
Key Concept #3 is that size can be reduced in high Implied Volatility (IV) and we can adjust to IV. A table displayed figures for a premium selling strategy of shorting the 1 Standard Deviation (SD) Strangles in SPX. The VIX levels were broken down into four quartiles. One column listed the credit received and the next the size reduction for the similar profit potential. One can trade about half the number of options when IV is in the highest quartile compared to when it is in the lowest. Tom and Tony also pointed out that one could also widen the strikes to receive the same credit.
For more information on Key Concepts discussed here see:
Options Jive from March 21, 2016: "Probabilities | Why Occurrences are Important"
Options Jive from April 13, 2016: "Three Key Concepts of Implied Volatility"
Options Jive from May 2, 2016: "Trade Size | Staying Consistent"
Best Practices from July 25, 2016: "The Tenets of tastylive"
Watch this segment of Best Practices with Tom Sosnoff and Tony Battista for the important takeaways and the three key concepts related to size management and consistency that can give you the best chance to be profitable.
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