August 5, 2014

Position sizing for options

I have written a lot on position sizing and have found this to be one of the most important and yet neglected aspects of trading.

Today I will write about using position sizing for options. Options seem to be very popular with retail investors for various reasons.

Say you are bullish and decide to buy Nifty ITM call option of 7700. This call closed today at 83. Since we are dealing with options, we should allow for substantial price swing (min 50%) so our SL should be Rs.40./-

Assuming a trading capital of Rs.1 lakh and risk per trade of 1%, the quantity you should buy is:
= 1000/40=25 shares.

But the lot size is 50 units so this means either 
your trading capital should be Rs.2 lakhs or 
- you should increase the risk per trade to 2% or
- reduce the SL on a trade to say Rs.20.

Forget the fact that the exchange is asking only Rs.4150/- (limited risk unlimited profits?). One SL hit means you are left with half your initial capital and are effectively out of the market. 

But when you follow the position sizing rules, you automatically are prepared and can last in the long run.

Comments welcome.

More info: Position sizing and risk management

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