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Introduction:

Selling Naked Put Option or Cash secured puts maybe the two most misunderstood stock option strategies amongst all the stock option strategies available.

Although it is not 100% accurate, roughly 75% of all the options traded expires OTM. And of course most people think that this 75% probability may give them any edge in trading options.

 One of the most common or repetitive questions that we receive from our students is, “How to properly calculate position size for undefined risk trades”?

Remember that, when selling Naked Options especially Short Calls options the maximum loss can be unlimited, as theoretically the stock can go to infinite and on the Short Put side, the maximum loss is always zero if the business goes bankrupt.

When we trade defined risk trades, it is very easy to calculate margin requirements, as often the option spread or the difference between strike prices would be the maximum loss on the trade, and this makes defined risk trades sizing very straightforward. However, when trading undefined risk trades, we have to take additional steps in determining which stocks to trade, to make sure that we always trade high quality business. And you can read for FREE our article on how we do analyze a business to trade stock and stock option below.

 There are a lot of articles claiming that selling options is like picking pennies in front of a steamroller, but people that write these types of articles don’t take in consideration the investors carelessness in terms of trading risk Management, and that is the main aspect why people lose money trading any type of derivatives.

As a full-time Trader/Investor, I highly recommend tastytrade as a broker to trade options

By taking advantage of tastytrade\’s $100 to $2,000 bonus, you can get started trading today with the best option trader broker

Like any other type of financial investment, derivatives also carry high risks of losing money, but the risk involved in trading short stock options is not embedded in the strategy itself but rather in the hands of those investors that trade these types of instruments without any sort of risk management or well defined trading plan.

At the time of writing this article on 31/03/2021, if you know a bit of derivative investment or you are in any circumstance involved in the stock market, you have probably heard about the famous hedge fund genius GME overleverage trade, which almost brought the whole stock market down.

And the GME trade, is a perfect example that articles about trading derivatives, or more specific naked options, mislead people in terms of risks.

The people involved in the GME short squeeze trade, was professional hedge fund managers, that should be doing the completely opposite trades that they did on GME, but instead they overleverage themselves to a point of being short more than the stock full float, or in other terms more than 100%, which is almost impossible to imagine how these so called professional are able to do it with hard earned investors’ money.

And the reason I brought up the GME short squeeze example into these articles, is to proof to you that the instrument that you trade doesn’t make any difference in terms of making or losing money in the stock market, but rather the way you treat your trading business, and when I say trading business, I mean exactly that, you need to take your trading career as proper business, and with any kind of business model, risk management is a very important aspect for the business to be a successful business of not.

If you go to a grocery shop for example, you will never find that the grocery shop sells only toilet paper for example, but rather a variety of products. And derivative trading or investing works the same way, if you put all your money into a single position the chance of failure will be much larger than if you diversify it throughout different products and different position sizes.

But remember, this article is about position size, which we haven’t even talked about yet, but so far you can see that no matter what type of investment you are in, if you don’t manage your investment with proper risk management, you will lose money no matter what, period.

You can pick the best 10 Stocks on the SP-500 and you can still lose money if you don’t invent properly, and when i say invest properly, I mean by looking after your position size.

And stock options, despite the fact of being an embedded leverage product in nature, still work on the way.

If you talk to all the authors that write articles about derivatives being a very risk product, and ask them if they ever did any type of research on why option sellers lose money, they will definitely not have a clue what you asking for, because most of them are just bloggers trying to make a living through articles and not investor that have real money on the line like us.

But from personal experience, from someone that made and lost a lot of money trading derivatives, I can tell you one thing with 100% sure, the one thing that investors that lost big money trading derivatives and especially short options have in common, is the fact of trading Wrong Position Size, and i made sure to highlighted in bold the word WORN, because if you are trading derivatives right now or have you traded before or even know someone that trades derivatives, you should know and be aware of the importance of Position Size, as it is the deal breaker between an inventor being a profitable trader or not.

And if you look at their trading journal and check all the losing trades, and simulate a trade management on the losing trades instead of being forced to be closed due to wrong position size, all the losing trades would have been very good winners and sometimes the best setups ever.

Doesn’t matter if you trade derivatives (Options of Futures), swaps, stocks, commodities or any other type of products, if you don’t look after your position size you will lose money no matter what, period.

Also when trading derivatives we need to keep updated our trading journal when selling short options, and we also need to make sure that we always manage our ITM trades by Rolling the trades for a Credit and not for a Debit, and you can also learn how to do it by reading the “HOW TO MANAGE CASH SECURED PUT” by jsut clicking on the link below and getting instant access to the article.

If you want to be part of our community of investors and learn why our risk management methods are so effective, just click on the button below. Our methods enables us to change the rules of the game in our favor, so we don’t need to wait for the stock to come back to our sold strike price to be able to close the trade for a profit, but rather we can apply some of our advanced trade management and be able to meet the stock half way, enabling us to close the trade with more premium collected than the initial premium received at the beginning to the trade.

Trade Notations:

• S = Current Stock Price
• K = Strike Price
• P = Premium
• DTE = Days to Expiration
• IVR = Implied Volatility Rank
• Moneyness = OTM
• IV = Intrinsic Value
• EV = Extrinsic Value

Position size:

WHY TRADING DERIVATIVES IS ALL ABOUT POSITION SIZE

For example:

Stock XYZ is trading at $100 per share, and two investors “A and B”, are willing to purchase 100 shares of the XYZ stock.

What is the difference between an investor “A” that bought 100 shares of XYZ stock outright for $100 per share, and an investor “B” that sold 1 contract of the $90 Strike Price and collected $2.00 for selling the option trade, and the stock dropped to $85, after 3 months?

As you can see in the above example, both investors have 100 shares of stock in play, investor A, by buying outright 100 shares of XYZ stock, and investor B, by selling 1 contract of the $90 Strike Price, which is equivalent to 100 shares of XYZ stock.

Let’s have a look and analyse the profit and loss of each investor after 3 months:

Investor A = ($85 – $100) = -$15 per share, or 15% Loss.

Investor B = ($85 – $90 + $2) = $3 per share, -3.4% Loss.

The above results show us a massive difference in investment loss, and investor B which has traded the so called \”Risk Trade\”, “short option” is way better off than the invest A, that has done the so called \”Wise Investment\”, by buying outright the 100 shares of XYZ stock.

But now I want to show you the main aspect that makes option sellers to lose money and article writers don’t understand or don’t want to learn before starting writing any useless and misleading articles about short options:

Let’s have a look at the same trade, but at this time we are going to intentionally over leverage the option seller position to a point that the investor B will be forced to close the trade for a loss, without being able to mange the trade due to wrong Position Size.

 Again in this second example both investors are still willing to purchase the stock XYZ.

But this time the investor A, still buying the same 100 shares outright of XYZ stock, and investor B, this time increases the contracts by selling 25 contracts of the $90 Strike Price, instead of a single contract, which is equivalent to 2500 shares of XYZ stock, and after 3 months the stock dropped to $85 per share.

Let’s have a look and analyse the profit and loss of each investor after 3 months.

Investor A = ($85 – $100) = -$15 per share, or 15% Loss.

Investor B = ($85 – $90 + $2) = $3 per share, -3.4% Loss (per contract)

The investor A, still losing the same -$15 per share, or -$1500, but at this time despite the fact of investor B, only be losing the same -$3 per share, this time we need to multiply it for 25 per contract, which would be max loss of -$7500, a loss of 5 times greater than the investor A. And teh reason i have highlighted the word multiply is becasue once you become overleveraged on a particular trade your loses do exactly that, multiplies and forces you to lose a perfect trading setup for a loss when the trade could have been a nice winner if you had the change to manage it with the right position size.

Now you can see that, if not used properly, trading derivatives like any other type of instrument can be a very risky type of investment in the hands of those investors that don’t know what they are doing.

By now after all these examples, we hope that you can understand and not be so afraid that derivatives or just like buying outright stocks, can both make you lose money, but at least now you know why and how to avoid losing money that you cannot afford to lose by looking after your position size.

But the question and the main thing about this article is, what is the ultimate guide to option “Position Size”

So, here we go, the way we go about it here at Unison Finance is:

Factors:

Factor 1:

• Risk per Trade: 3 to 5% per trade.

When we enter a new short position, our maximum risk per trade is always between 3% to 5%.

Factor 2:

• Always sell the same amount of contracts that we are willing to buy the stocks.

For example, if we are willing to buy 500 shares of stock XYZ, we only sell 5 options contracts, and the 5 option contracts or 500 shares must be inside our well defined risk per stock purchased.

Sometimes we do purchase more than 5% portfolio worth of shares of a particular stock, as the maximum risk between derivatives and stocks are not the same for us.

Derivatives are always between 3% to 5%, but investing in stocks we may go up to 10% depending on the stock trade opportunity as well on the quality of the stock.

If you want to learn how we choose our High Quality stocks to trade derivatives and Stocks, please join our community by clicking in the link below !!!

Factor 3:

Factor 3 is a more advanced and complicated method, but still work very well for us. We apply factor 3 by calculating position size through Std (Standard Deviation).

Here at Unison Trading we use 2 Std for each trade entry. Normally 2 Std happens 5% to 7% of the time, and if we are aware that the stock can move anytime 2 Std against us, we will know in advance how much we will be losing in a particular trade.

If stock XYZ with 1 Std is 85 and a 2 Std short put strike price of $75 is trading at a Premium of $1.50 per share, and if XYZ moves to $85, our current loss in this trade would be ($75 – $85 + $1.50) * 100, which would be -$850, and considering that the margin requirement for this trade is $1,250, it would cover the trade risk to 2 standards deviations.

 And an investor with a $200,000 portfolio size, could sell 4.7 short option contracts on XYZ stock, but in this case to be even more conservative we would have rounded down the contracts to 4.

Please note: This is just an estimation, but roughly 95% of the time this gives us a reasonable estimation, but losses could be larger than this, so keeping your position size small when trading short options is very crucial and important.

LEARN FOR FREE OUR TWO MOST POPULAR STOCK OPTION STRATEGIES

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Trade Example:

This is a quick example of what kind of trade management we do here at Unison Trading.

Ticker: 

Ticker symbol BA (Boeing):

Chart:

On Feb 10^th ,2020, Boeing, the ticker symbol BA, was trading at the $335, and we found the level of $310 to be a good support level opportunity to sell a short option on Boeing, so we enter the follow trade:

Input: Parameters

We sold the OTM $310 Strike Price and initially collected $350 per contract on a 44 DTE trade, which would provide us with an annualized rate of return of 9.47%. The annualized rate of return for this particular wasn’t much due to the very low volatility at that time, but considering that the trade had an 8.51% downside protection, we found that to be a very good trading set-up.

Trade Profit and Loss Diagram:

1 Short $50 Put at $1.50 premium per contract.

On 20^th of March 2020, the stock dropped all the way down to the $95.00 price level, and at this point we started to apply our Advanced Risk Management.

During trade management, we managed to decrease the sold $310 Strike Price from $310 to $202.5, a decrease of 34.7%, which in normal circumstance an investor would need to wait for stock to be trading back to the $310 level to be able to get out of the trade, but because we have many tools that allows us to deal with any type of bad stock market conditions, we managed to work out our strike price down $107.5 or 34.7% which was a significant amount.

And on June 6^th, 2020, as the stock price traded all the way up to the $231 price level, we had the opportunity to Buy Back the option for $0.02 cents.

Trade Management:

For the whole trade we had the following Rolling Trades:

• Roll 1: Credit Received $1.25
• Roll 2: Credit Received $0.45
• Roll 1: Credit Received $0.85
• BTC = $0.02

Total Trade Premium collected: ($3.5 + $1.25 + $0.75 + $1.75 – 0.02) = ($7.23) = $723 per contract.

• DIT: 117
• Total Premium = $7.23
• Final Annualized Rate of Return: 11.17%

Therefore, our final Annualized Rate of Return was greater than we had at the beginning of the trade, the final 11.17% annualized rate of return was 1.7% higher than the initial 9.47%.

But the main thing you should take as a final takeaway from this trade management example, is that fact that we managed to decrease our sold Strike Price from $310 all the down to $202.5, which in terms of applying risk management on a bad trade, it is good as it can get.

We as an option seller, we always need to make sure that we put risk management first on every single trade, and here at Unison Trading all our risk Management is done prior to entering the trade, because we do believe that once we press the trigger it is too late to worry about it.

If you are interested in learning more how we manage our trades, just click on the link below and join our community for investors and learn and trade with us.

“Remember that, we don’t get paid for trading, but rather from making great decisions at the right time”

Having a journal with all the details of our trade entries and trade management, is the best way for us to keep track of our trade Break Even point.

Let’s have a look at an example of a naked put trade where we Roll the trade until we manage to close the trade for a profit.

In this example the trade inputs are:

• S = $60
• K = $50
• P = $1.50
• DTE = 30
• IVR = 30
• Moneyness = OTM
• IV = $0
• EV = $1.50
• DIT = Days in Trade
• BTC = Buy to Close
• STO = Sell to Open
• BE = Break Even

With the stock trading at the current price of $60, we sold the $50 Strike Price Short Put for a Premium of $1.50 with 30 DTE, and the option moneyness was OTM, which means that the current stock price is above the sold strike price, and if nothing change until expiration date, the trade will be expiring worthless.

With 20 DTE or 10 DIT, the stock dropped to $47.50 and the option is $2.50 ITM. At this point we can manage the trade by rolling the option for a future expiration date or simply let the trade play on until expiration date.

If the option still ITM at the expiration date, we will be getting assigned 100 shares per contract sold, and at this point we can sell the shares at the market price and re-establish the same trade by Rolling the option forward, or just get hold of the stock and starting selling covered call on it, but either method we choose we need to keep track of all the premium collected so far.

Let’s see the example where we just roll the option for a future DTE, by doing the  following procedures:

Roll 1:

Trade expires at $47.5

• BTC the $50 Strike Price for $2.50
• STC the same $50 Strike Price for a Credit of $0.50, with a new 30 DTE.
• Net Premium = (1.50 + 0.50) *$ = $2.00
• New BE = $47.50

And after the 30 days the volatility decreases from 45 to 40 as the stock recovery from $47.5 to $48.50, but the option still trading ITM, so at this point we can do the following trade management.

Roll 2:

Trade expires at $48.5

• BTC the $50 Strike Price for $1.50
• STC the same $50 Strike Price Credit of for 0.75, with a new 30 DTE.
• Net Premium = (2.00 + 0.75) *$ = $2.75
• New BE = $47.25

Note: At the point of the second rolling, we could just have sold the stock outright at the market price for $48.50 and still making $0.50 on the trade, which is the ($48.50 – $50 + $2) = $0.50, but we opted to keep managing the trade in this particular example.

But here is where when most of the investors get the maths wrong, when we just did our second rolling, in our brokers trading platform the option would be showing the $1.50, which is what we paid for the second rolling. And at some point once the stock starts to recover, the option will be starting to decay as well, for example, if the stock is trading at the $49 price, we can also close the trade, by buying the option back for $1 and keep the $1.75 profit.

But in some cases if the stock is trading deeper ITM, like $45 for example, on the second roll we would have paid $5.00 to roll the trade. And at the broker trading platform the option would be showing $5.00, which would be the price paid for rolling the option, and at some point if the stock start to recovery and the option start to decay, let say to $4.00 for example, some investor thinks that the $1.00 decay difference is profit, which is not, because our breakeven on that option would, the $5.00 minus the $2.75, or $2.25, we we need to be careful we dont lock in loss during trade management.

The $2.25 option buying back price is the point where we can start to think about buying back the option for a small profit or scratch, or just wait to see if the stock expires OTM, so we can keep the full $2.75 premium collected during this trade.

Therefore, it is very important for us to ignore the brokers platform option price, and keep focus on our BE point calculations.

And after the 30 days the volatility decreases from 40 to 25, and the stock finally is trading OTM again, and at the expiration date the stock recovers to $52.50 and the option expires worthless.

• Net Premium = (1.50 + 0.50 + 0.75) *$ = $2.75
• New BE = $47.25

There are plenty of others trade management where we can significantly improve our final profit on a particular bad trade, and this is what we do here at Unison Trading, but no matter which approach you may take, just make sure that you always keep track of all the rolling credits received during trade management, so you are aware exactly where the final trade BE is.

PUT YOUR KNOWLEDGE INTO PRACTISE: JOIN OUT TRADING COMMUNITY

Here at Unison we show our Real Trading Statement Results and we dont hide anything from our clients … Real Statements from Interactive Brokers . Our Trading return goals are very Realistic & Achievable and Honest, that is why we are consistently profitable year after year.

If you are after honest traders that is really profitable and dont sell BS and unicorn type of returns for clients and would like to trade like a professional investor with the long term goal in mind, you are absolutely in the right place.

Here at Unison Trading we are not concerned how many trades we put a day but rather how many quality trades we have traded on that day, so please don’t expect to join us and hoping for daily adventure and excitement, we take our trading and business very serious as we find it the greatest opportunity for us to create/maintain wealth and this opportunity is not done by excitement but rather professionalism on everything we do.

Although, here at Unison Trading we don’t trade looking for excitement neither for having fun, we are very aware of the Law of Large Numbers (Number of Occurrence’s), as we always make sure that our number of occurrences are in place so the probabilities can play out. Remember that the maths doesn’t lie.

Why Follow our Trade Alerts

• 100% Real Broker Statement (Interactive Brokers)
• Consistently Monthly Income
• Realistic – Achievable and Honest Results
• Lower the cost basis of your portfolio (stock)
• 100% Transparency
• Generate Increased return on investment
• Control Stock without owing it
• Leverage Capital
• Reduce Risk

And of course the main thing as a professional trader, Be Profitable .

What You’ll Get

• Real-Time Trade Entry
• Real-Time Trade Exit
• Real-Time Trade Management

All streamed live straight to your WhatsApp, so you can just check the alerts and place the same trades with nothing hidden.

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