How to Price and Trade Options: Identify, Analyze, and Execute the Best Trade Probabilities, + Website

CHAPTER 9 Portfolio Management

We have spoken about how to choose individual trades, how to best execute your trades, and when to exit trades both as winners and losers. Once you have a number of trades on your sheets, what should you do to control your overall portfolio’s risk? How do you know what the overall risk really is? This is perhaps the most difficult area of trading. There are many schools of thought on the issue. We will begin our discussion by exploring a more academic viewpoint on the issue and proceed to a more practical approach. I must caution you that for every educator you read or listen to, you will more than likely get a different answer as to the best way to control your risk. And even if all educators had a similar answer, each individual trader has his or her own risk appetite, financial situation, and pain threshold for withstanding losses. Therefore, there is no “one size fits all” solution. What I will deliver to you is a solid framework for how to view your risk, some potential trade ideas to help mitigate your portfolio’s risk, and some rules of thumb as to how to size your trades. You may be wondering why sizing your trades appears in a portfolio management discussion. In actuality, proper trade sizing is probably the single most important area of risk management. Let us begin by talking a bit about risk and diversification of risk.

Two Types of Risk

Most people hear the term risk and think it refers to how much they can lose. Though that is ...