does the KC calculation have any practical value in calculating optimal position size when trading long option premium ? When I calculate the KC value using my w-l ratio and profit loss numbers I get .19 Or 20%. But I would never put this much of a portfolio into one trade buying premium (no matter how good risk management/stops, etc). What am I missing ? Does it have to do with the number of shares controlled by 1 contract vs the nominal premium ? Thanks
it also is going to depend on how far dated the options are , how in or out of the money they are in... if you are considering holding them to expiration etc etc...
When long vol, you have an assymetric payout (meaning you get X:1 where X >> 1) but the likelihood is low. You are probably over-estimating that likelihood. It's easy to do that.
@newwurldmn is what you are referring to from the effect of gamma ? I actually try not to incorporate the potential positive of gamma when calculating targets ( ie :gamma would just be icing on the cake), but on the other hand isn't gamma a possible benefit of long vol ? Thanks
here is an example... 1 month dated 20 delta otm call option price 100 dollars... that is your entire position size.. you have a target of say 200 percent you will hold until you get the 200 percent or it expires worthless... here is another example... you buy a ditm call option and plan on using it as a cheap surrogate to owning the stock, you put a condition on pro grammatically or manually that if the stock goes below a certain level you will sell the option, or if it goes up to a certain level you will sell, and you have a time element in which after a month or some amount of time you close the position down no matter what... there are so many factors in trading options... you have to figure out how you going to trade them first then consider how to figure that into your position sizing... sooo there you go.. some food for thought
Oh, I have the specifics, including the track record. If you do not you can not calculate KC in the first place. I'm staring to believe that the inflated KC stems from what ND is referring to in post 4, the assymetric payout that can't be relied on in the future.
If your Kelly Criterion says it is 0.2, that means your optimal bet each time is ~ 20% of your capital allocated to this "game". So, if trading monthly long options is your game, your optimum sizing is ~ 5 to 6 option trades per months each ~ 20% of your total risk capital. This is not an unreasonable number IMHO for a successful trader like you, it gives you ~ 60 trades a year. A more interesting question is: What amount of risk capital should I risk trading options, out of my total portfolio. I think if you plug numbers into the formula, a number between 10% to 20%, (like your 0.2) is not an unusual number, i.e., one should not risk more than 10-20% of your tradable amount on options. I am just an amateur so not sure if I make sense. You pros please chime in and educate us. Best wishes.
Start out at 1%.. that's my advice... And use the entire premium paid on most options as your stop loss...