Risk management for trend following system

Discussion in 'Risk Management' started by razf1, Sep 25, 2005.

  1. razf1

    razf1

    I currently trade options using a trend following system against the underlying index ( SPX, NDX ). I buy next month's calls or puts in the direction of the signal with a delta of 1.

    While the underlying signals do not lead to excessive drawdowns I would like to minimize the exaggerated effect this has on my positions since I am only trading options. What is the best way to minimize my risk? Should I buy slightly ITM options as insurance against my directional trades?

    I would appreciate any insight you guys can provide on this.

    -raza
     
  2. limit your risk to 1-2% per trade

    $ value of stop

    TrailStopAmount = .5 * ATR(10); // use whatever volatility stop your system uses
    Trade amount = ((.01 * Equity)/TrailStopAmount * value of option)); And set a limit on the formula to a certain % of capital, low % for big account say 7.5% for a single trade, , a bit higher % for smaller account if low position sizing isnt an option for you.

    Its too expensive to hedge, and it doesnt really define your risk per trade, IMHO. So your essentially hedging by controlling Position Size.
     
  3. Can a directional OTM option strategy afford insurance by way of ITM options ? Adjusting the % of ITM's to OTM's to underlier movement and MATURITY of the directional signal would get you some insurance at lower overall costs. Perhaps even a lower Delta on the ITM option insurance? I am new to option engineering and trading so please bear with me. I am still learning the Greeks. :D