One of the most frequently asked questions I get from friends and associates concerns option position sizing and how much to allocate for each trade. This is always a difficult question to answer and one that affects each investor differently.
What makes it complex is that every investor has a different level of money they can afford to invest along with different levels of income and age. Obviously someone in their 20’s can be a bit more aggressive than someone who is nearing retirement.
When it comes to trading options, the following advice may not be the right choice for you but it should give you a better idea from which to base your decisions. For my options trading account, I do not risk more than 10% of my assets in any one position. For someone that is new to trading options, then your starting point should be a little lower, like 5% due to your lack of market experience.
The 10% rule is my comfort level, based on several years of investing experience but I have known investors who have opened option trading accounts with $2,000 and risked half of it on their first trade. Needless to say, if the trade went south, they were either done with options or reloading their trading account. To me, that is gambling, and it’s important to think of trading options as a business and not a “get rich quick” scheme.
You should consider a discount broker and not a full-commission or “service” broker. The fees from the full service broker will be substantially higher and they will usually frown on you (this also comes from my own personal experiences). The discount brokers are pretty reasonable charging anywhere from 75 cents to $1.50 per contract with a $15-$25 minimum. A “broker-assisted” trade could cost in the range of a $45-$60 (or higher) minimum and as much as $2.25 per contract.
Also have an open mind that every option trade is not going to be a winner. With that, you must consider the percentage amount you are prepared to lose if you happen to be in a trade that is not going your way. My set amount is usually 50% depending on market conditions due to the nature of a leveraged position. What I mean by that is – think in lots of 10 contracts – it means you are controlling a 1,000 shares of stock. With stocks, my stops are usually 20%-25% below a purchase price.
In the end, it all comes back to you and what you are comfortable with. These are some of the guidelines that I use but they are important, especially if you are just getting started in option trading. It’s a far cry (and greater thrill) from trading options on paper to when you actually make your first trade. Going in blind will only increase your chances of frustration.