Risk Appetite and Options Trading

How to choose the right options trading method according to your risk appetite.

Options trading is well known for its leverage and versatility. Through its hundreds of options trading strategies as well as countless ways of exploiting its leverage, options trading can be adapted for any trading style and any trading objective. Since it is so versatile, how should an options trader choose the most profitable way to trade options?

 

Most options trading beginners read amazing stories about how some people make millions trading options in a certain way and then try to duplicate what those people do only to be greeted with defeated. Indeed, what works for others may not work for you. Why is that so? It is because success in options trading requires a matching of the right method with your risk appetite!

 

An options trader’s risk appetite decides when the options trader’s emotional button, or panic button, gets hit. When the panic starts, everything screws up. This is why options trading methods that work for some people don’t work for others.

 

Below, I shall provide a general guideline on what options trading method matches each kind of risk appetite and fund size.

 

Big Fund, Big Risk Appetite

When you have a big fund and a big risk appetite, you might want to optimize your returns by swing trading with options using the majority of your fund. You may also use a smaller portion of your fund to place out of the money bull call spreads or bear put spreads on stocks that are likely to stage a significant breakout due to earnings release or take-over.

 

Big Fund, Small Risk Appetite

Most options traders fall into this category and are people with hard earned savings who aim to make a small reliable income while taking as little risk as possible. Such people should use low risk position trading strategies such as Covered Calls or the Ride The Flow strategy in order to produce a small residual income monthly without the need for active trading.

 

Small Fund, Big Risk Appetite

If you have a relatively small fund and is willing to take big risks with it, you may wish to day trade options by identifying stocks that will move within a day and then maximize your exposure using in the money options, selling them the moment the stock turn against you within the day itself and then move on to identifying other opportunities, all within a single day. The aim is to make as many profitable trades within a day and stop if your loss limit is hit for the day. This strategy is not that productive for bigger funds due to the relatively low level of liquidity of options which may not be able to fill extremely big positions quickly.

 

 

Small Fund, Small Risk Appetite

Oddly enough, many people fall into this category as well. If you only have a small fund and you cannot afford to take much risk, you may want to buy long term (expiring one year later) in the money LEAPS call options on good quality growth stocks simply as a leveraged replacement for stocks. LEAPS call options which are deep in the money moves almost dollar for dollar with the underlying stock while costing only a fraction of the price. Small funds will not be able to reap the benefits of position trading as much as bigger funds can due to commissions and spread loss.

 

Following these general guidelines along with your specific considerations and unique situation, you may be able to choose a sensible approach to options trading which will truly benefit you for the long term.

 

Find out more about options day trading, swing trading and position trading.