Money Management in Credit spread strategy

Discussion in 'Options' started by nell, Oct 11, 2008.

  1. nell

    nell

    Hi guys,

    I'm learning money management right now, and found very curious and contradiction money management with mine as a options credit spread trader.

    Are you experience the same things ?

    I came to a conclusion, most of Money Management system do not let us to risk more than more than 3% of our equity. Based on my trading system-it's not worthed for me if i only risk 3% of my equity.

    As example, let's say you have $10,000, and your strategy based on IronCondor/Calendar/etc (market neutral strategy), simply we just put $1000 for each strategy and for 10 types of stock. Therefore, we have 10 types of stock that each cost $1000 margin, most of the time we target 10%-20% profit, with risk reward 1:1 or 1.5-3 :1 (more risk) because we're in credit spread strategy that have stinky risk reward ratio. It means, we are risking 1%-3% of each our basket, and totally we risking 10%-30% of our equity.

    It makes no sense for me if usually i risk 10%-30% risk, and with this money management i must lower 10x to be at 3%, and that also means i only have 1%-2% reward from my entirely portfolio in a month (usually i collect monthly premium)

    I analyze that, the motivation behind 3% risk, is because mostly traders doing trade with multiple transaction daily and with smaller winning ratio but high reward, but i don't think it can be applied in trader who use credit spread, am i correct ?

    and another reason, because it's because we're selling premium monthly basis, so it hard for us to practice the 3% money management risk.

    All we see is the greeks (delta/gamma/vega/theta) and make them balanced in whole portfolio

    Do you have better idea ? or is there any system specially for credit spread trader like me ?

    Is there any good book for money management ?

    Thx for sharing buddy
     
  2. Nell,

    Money management is an essential skill.

    But, so is risk management of your portfolio. These two ideas should not be separated.

    In your scenario, you take a $10,000 account and want to know if limiting losses to 3% - per trade - is realistic. You also correctly point out that that idea is basically for day traders who open and close a much larger number of positions than you do.

    You can intelligently adopt that 3% rule if you want to do so - but your mistake comes from assuming that you must risk $1,000 per trade.

    To adopt that 3% rule, trades must be smaller.

    Example: buy a one-lot of an iron condor with wings that are 10 points apart. Collect (for example) $300.

    You can afford to risk only $300 per trade. Thus, stop yourself out when the IC moves to $6. That way trading iron condors is very feasible. This trade has a good risk/reward ratio. But, it's only a one-lot.

    If you prefer to trade options that are further OTM, you can buy an iron condor and collect $100. But, risking $300 gives you a bad r/r ratio - even though the chances of taking this loss are small (but in today's very volatile market, they are much greater).

    I assume you don't want to trade one-lots and I agree that the 3% rule does NOT apply to you.

    What you must do is apply good risk management. that means if your IC can earn a profit of $X, you must close the position when losses reach 125%, or 150%, or 200% of $X. Pick your own stop-loss point.

    But you MUST NEVER sit and watch and hope, the market reverses. You cannot allow for the possibility of losing 500% or 900% of $X on any trade.

    Focus on risk management.

    Think about money management when you size the trade, but 3% is not likely to work for you.

    Mark
    http://blog.mdwoptions.com/options_for_rookies/
     
  3. joe5555

    joe5555

    Mark wrote:

    Example: buy a one-lot of an iron condor with wings that are 10 points apart. Collect (for example) $300.

    You can afford to risk only $300 per trade. Thus, stop yourself out when the IC moves to $6. That way trading iron condors is very feasible. This trade has a good risk/reward ratio. But, it's only a one-lot.



    Hi Mark:

    This section "went over my head" so to speak. In your example, 1 one-lot IC with 10 pt spread would cost $1000, so if he collected $300, that is a 30% premium. If he set his stoploss to buy it back at $6, then his net loss would be (-3+6)*100 = -$300.

    Am I on the right track ? Also, to get 30% premium, is that 2 months away ?; and with what sort of deltas on the BrCS and BlPS (10% ???)

    Thanks Mark. I enjoy reading your postings.
     
  4. MTE

    MTE

    Mark,

    While I generally agree with you, the flip side of setting a stoploss at 100% (i.e. getting out at 6 if you took in 3, for example) or any level for that matter in an IC is that you alter the probabilities. That is, there's always a chance that the volatility that took the underlying outside your range can move it back in and by getting out at 100% you miss out on that probability.

    I'm not saying you should always stay in a trade, but it's something to consider.
     
  5. 1. Yes, his loss would be $300.
    That's he 3% of his account he was willing to risk per trade.

    2. The iron condor doesn't 'cost' $1,000. That $1,000 is the maximum you would have to pay to exit the position (both options ITM when expiration arrives).

    3. When collecting cash, you BUY (not sell) the iron condor. He would collect $300 now and stop himself out at $600. Maximum loss is then 3% of his account, or $300.

    4) To get $300 credit on RUT iron condors I must usually go 3 months out. With today's high IV, I'm willing to do buy 2-month iron condors.

    5) Important: Time remaining and cash collected are not RULES. Those parameters suit my comfort zone and may be very inappropriate for you.

    6) I have no idea what BrCS and BlPS means.

    Mark
     
  6. Poster was speaking about trading iron condos AND risking no more than 3% of his account.

    I'm not suggesting those parameters for anyone. Am merely pointing out that 3% per trade risk and an account of $10,000 makes it very difficult to trade iron condors.

    That's all.

    Mark
     
  7. MTE

    MTE

    That I agree with.
     
  8. joe5555

    joe5555

    Thanks for your reply Mark.

    I agree with your statements.

    BrCS and BlPS = Bear Call Spread
    and Bull Put Spread ;
     
  9. I've been trading options since 1975 and I've never seen those abbreviations.

    Mark
     
  10. joe5555

    joe5555