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Options Investing Strategies (Money Management
Strategies)
Depending on their trading styles and risk tolerance,
traders can select among a number of money management approaches for
options trading; these will dictate how much to invest (and reinvest) in
a given trade. Below, we outline three such strategies and show their
benefits as well as potential drawbacks.
Strategy 1: Reinvest both the principal and accrued
profits
One of the most popular money management
strategies involves the reinvestment of both the principal and
profits after each (positive) trade. For instance, if a trader
allocates $2,000 to a first trade and then makes a 50% profit,
he/she would be able to invest $3,000 in the following trade (the
principal of $2,000 plus the $1,000 profit). By investing in this
fashion, a trader will benefit from the power of compounding;
however, trading options this way is aggressive and very risky - a
trader could quickly wipe out an entire portfolio.
It is not recommend approach for options
trading!
Strategy 2: Invest a fixed percentage of the
portfolio
Another popular money management strategy is to
allocate a fixed percentage of the portfolio to each trade. For
instance, a trader may decide to invest 20% of a portfolio in each
trade. Assuming a $10,000 portfolio, the trader would thus invest
$2,000 per trade. Should a trade result in a 50% profit, the trader
would then have $11,000. He or she could then allocate $2,200 (20%
of $11,000) for the next trade. This approach to options trading is
considered conservative.
Strategy 3: Invest a fixed amount
A third way to allocate funds is to invest a fixed
amount per trade. For instance, a trader with a $10,000 portfolio
could set aside $2,000 for each options trade. Even if a trade
resulted in a 50% profit, the trader would still only invest $2,000
in the next trade. This strategy is less profitable than strategy 2
discussed above; however, it allows a trader to recover more quickly
from (a) losing trade(s). In order to increase their profit
potential in good times, traders sometimes combine this approach
with a higher investment once a certain portfolio size has been
reached. For instance, a trader may decide to invest $3,000 per
trade once his or her portfolio has grown to $15,000.
The comparison table below shows how a portfolio would
fare using the three money management strategies discussed above. The
following assumptions are made:
- The
initial portfolio value is $10,000;
- Three
options trades are made: The first leads to a loss of 70%; the
second and third each produce a gain of 50%.
| |
Strategy #1
(reinvest everything) |
Strategy #2
(reinvest
20% of the portfolio) |
Strategy #3
(invest
$2,000 per trade) |
Invested
into
a trade |
Profit
from
a trade |
Total
Profit |
Invested
into
a trade |
Profit
from
a trade |
Total
profit |
Invested
into
a trade |
Profit
from
a trade |
Total
profit |
| Initial Portfolio Value |
$10,000 |
$10,000 |
$10,000 |
| 1st Trade:
-70% |
$10,000 |
-$7,000 |
-$7,000 |
$2,000 |
-$1,400 |
-$1,400 |
$2,000 |
-$1,400 |
-$1,400 |
| 2nd Trade:
+50% |
$3,000 |
+$1,500 |
-$5,500 |
$1,720 |
+$860 |
-$540 |
$2,000 |
+$1,000 |
-$400 |
| 3rd Trade:
+50% |
$4,500 |
+$2,250 |
-$3,250 |
$1,8922 |
+$946 |
+$406 |
$2,0000 |
+$1,000 |
+$600 |
| Portfolio at the end |
$6,750 (33%
loss) |
$10,406 (4%
profit) |
$10,600 (6%
profit) |
| |
A very aggressive
and highly risky strategy. The trader
risks losing the entire options portfolio with one bad trade,
making it very difficult to recover. |
A conservative
strategy. While it may also be difficult
to recover from losing trades, a recovery is often much faster
than in strategy #1. This strategy has some compounding effects.
The risk of losing the entire options portfolio is relatively
small. |
A conservative
strategy. Recovering from losing trades
is comparatively easy. This strategy has no compounding effects.
If several significant losses in a row are sustained, the
strategy could still result in a total loss of one’s options
portfolio. |
| |
Not
recommended for options trading |
Recommended for options trading. |
Recommended for options trading. |
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Best Months
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Apr 2008: |
+224% |
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Mar 2008: |
+241% |
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Feb 2008: |
+341% |
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Dec 2007: |
+227% |
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Nov 2007: |
+167% |
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Oct 2007: |
+127% |
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Jan. 2007: |
+83% |
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Nov. 2006: |
+122% |
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Oct. 2006: |
+71% |
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Aug. 2006: |
+74% |
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July 2006: |
+73% |
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Mar. 2006: |
+75% |
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Based on actual trades autotraded by major brokers |
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Uncovered SPY Options
Signals
Past 2 Months |
|
+338%
 |
-0%
 |
Our
Signals |
Buy
& Hold |
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As of 5/16/2008 |
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