Options Risk Management: Protecting Your Portfolio
Learn the risk management principles that separate successful options traders from those who blow up their accounts.
What is Options Risk Management?
Options Risk Management is the practice of controlling potential losses through position sizing, diversification, and predefined exit rules. It's the foundation of long-term trading success.
Most traders focus on entries, but exits and position sizing determine profitability. Risk management isn't optional—it's essential.
TL;DR - Quick Answer
Risk 1-5% per trade max. Know your max loss BEFORE entering. Define exits before entry. Never sell naked options without understanding risk. Diversify across underlyings and expirations. Cut losses, let winners run.
Position Sizing
Never risk more than 1-5% of your account on a single trade.
Buying options: Max loss = premium paid. Easy to size.
Selling options: Max loss can be much larger. Use spreads to define risk.
Example: $50,000 account, 2% risk = $1,000 max loss per trade.
Know Your Max Loss
Before every trade, calculate your worst-case loss.
- Long calls/puts: Premium paid
- Vertical spreads: Width - credit received
- Naked puts: Strike price × 100 (minus premium)
- Naked calls: Unlimited (avoid these!)
Exit Rules
Define exits BEFORE entering:
- Stop loss: Exit at X% loss (e.g., 50%)
- Profit target: Exit at X% gain (e.g., 50-100%)
- Time stop: Exit if thesis hasn't played out by date X
Diversification
- Spread across multiple underlyings
- Mix expirations
- Balance long and short positions
- Don't correlate all positions
Common Mistakes
- Oversizing positions
- Holding losers hoping they'll recover
- Selling naked options without understanding risk
- No exit plan before entry
- Concentrating in one sector
Key Takeaways
- Risk 1-5% max per trade
- Know max loss before entry
- Define exits in advance
- Use spreads to cap risk
- Diversify positions
Related Options Strategies
Vertical Spreads
Defined-risk strategies.
Options Greeks
Understanding position risk.
Understanding related strategies helps you choose the best approach for your market outlook and risk tolerance. Each strategy has unique characteristics that make it suitable for different market conditions.
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