How to approach risk management as a beginner
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Thinking realistically about results, implementing technical strategies like spreads, butterflies, risk reversals can help to manage risks better. In this article, we’ll dive into risk management, focusing on how to deal with risks as a beginner options trader.
To explore this topic, Chris Douthit from Options Strategies Insider and Kim Klaiman from Steady Options will provide us with some of their experiences.
How should a beginner options trader manage their risks?
How to approach risk management as a beginner
Markets do not always make perfect sense: this means risk-reducing techniques are almost a must for all traders. A good idea might not work just days after investing, like the story about Chipotle below.
Essential Principles for Options Trading Success
Achieving proficiency in options trading fundamentally requires robust risk management capabilities. This foundation begins with prudent investment selection—resist the temptation to pursue every promising opportunity that crosses your path. Thorough investigation of each potential transaction, combined with clarity regarding your objectives and rationale, proves indispensable. Simply removing unfavorable trades from consideration dramatically enhances overall performance outcomes.
Nevertheless, even thoroughly researched opportunities demand implementation of suitable strategies for effective risk mitigation and sustained profitability. This involves deploying spreads, iron condors, butterflies, risk reversals, and similar options techniques designed not merely for profit generation but also for loss limitation through capped maximum exposure and reduced initial capital requirements.
Prudent investors must maintain continuous awareness regarding their financial commitments, invest thoughtfully, and maintain realistic performance expectations. Avoid excessive aggression or overconcentration in any single position. Regardless of how compelling a particular opportunity appears initially, market conditions can reverse abruptly without warning.
Consider those maintaining substantial bullish positions on Apple during Steve Jobs’ departure. Reflect also on investors heavily positioned in Chipotle shares, despite favorable technical patterns, just prior to widespread food safety incidents affecting numerous patrons.
Novice options participants naturally gravitate toward opportunities promising exceptional returns. However, they frequently overlook the fundamental principle that extraordinary returns inherently carry substantial risk exposure. The pathway begins with establishing sound investment decisions within your portfolio, followed by implementation of appropriate hedged options structures, enabling significant returns while maintaining portfolio protection.
Let’s see Kim Klaiman’s take on risk management:
“We manage risk mostly by position sizing. The position sizing depends on the strategy and based on the maximum amount we are willing to risk per trade.
For example, if we are willing to risk 2% of the account per trade, and a certain strategy typically loses no more than 20%, we will allocate 10% to trades using that strategy. For more risky strategies that can lose 40% we will allocate only 5% of our account.
In addition to position sizing, we hedge our trades. We trade spreads only, never naked options (long or short). Specifically, the Anchor strategy is always hedged with put options.”
– Kim Klaiman, Steady Options
How should a beginner options trader manage their risks?
Where to look for more?
Hope you liked this quick rundown on what options are. If you’d like to go deeper, navigate to one of the articles below:
- What is options trading?
- Options trading examples
- The pricing of options
- Options trading for beginners
- What are the benefits of writing an option?
- What is a binary option?