## Options Education

### Position Sizing

Position Sizing

The way we structure the size of the trades at my hedge fund is by following the money management parameters we reviewed in yesterdayís blog.    The rules are:  no one trade can risk more than 2% of the capital, and in any month that you lose 6% the fund goes flat and stops trading for that month.

Letís assume the fund has \$2MM under management.  Following the 2% at max risk means that we could risk up to \$40K on one trade.  If we traded a RUT condor with 10 point wings spreads where condor uses \$1K of margin (assuming reg-T) one would think that you could do 40 RUT condors.  That is 40 X \$1K = \$40K which is 2% of \$2MM.    Actually, this is correct if you are assuming that you will let the condor lose the maximum it can.   In practice I use a smaller allowed loss before I pull the trade.   For example, in the RUT condor I might have a profit target of 15% of margin and an allowed loss of 20% of margin.  Hence, if one condor lost \$200 (20% of \$1K) I would exit the trade instead of letting it lose the maximum \$1K.   If you are only allowing the trade to risk \$200 then if you can risk \$40K (2% of \$2MM) per trade then you could trade up to 200 RUT condors.

In practice, at the fund we wouldnít normally go up to 200 condors to have a trade risk 2% of capital.  Usually we risk 0.5% to 1.5% of the capital per trade not the full 2%.  We would go up to a full 2% only if the thought the trade was in a very good trading environment and we it was time to pull out all the stops.  But, we never, ever, go above the 2% risk allowed per trade.

I highly suggest that you follow strict position sizing based on your money management parameters.   These rules will keep your funds safe and you will avoid blowing up.    Iíve seen many accounts blow up due to poor money management and position sizing.

Mark Sebastian is a former market maker on both the Chicago Board Options Exchange and the American Stock Exchange. Along with his role directing the path of education for Option Pit, Mark is currently the director of risk for a private hedge fund. He writes a daily blog, the Option Pit blog, formerly Option911. Sebastian has been published nationally on Yahoo Finance, Google finance, Financial Times Alphaville and is a featured contributor for TheStreet.com. He is also published regularly at SFO, the Options Insider, and is one of the Co-Hosts of The Option Block Podcast, a featured Podcast from Options Insider Radio. Mark is the managing editor for Expiring Monthly: The Option Traders Journal. Sebastian has a Bachelor's in Science from Villanova University. To learn more about Option Pit and their mentoring services, please visit: http://www.optionpit.com

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