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Money Management for Options Traders

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Stocks in this article: PSX

In a way the key to making money is all about position sizing. For positions that are likely to turn out to be losers we want a position size of zero. So in that sense position sizing is everything.

My simple plan for option traders is to figure out how many trades you can monitor at one time. Then subtract 20% of your capital as a cash cushion for emergency contingencies. The remaining 80% of your capital should be spread evenly into the number of positions you have. So if you choose to have 20 positions the margin for each one would use up 4% of your capital.

Sometimes it happens that all your capital is used up but there is a new opportunity that you would like to pursue. It makes sense to close out an old trade if it is profitable and has little profit left in it. For example we made an investment by selling the Phillips (PSX) April 55 puts. The option is now quoted at $0.05 bid and $0.10 asked. The margin is still $550 for this position. Using the $0.10 price tells us that there is less than 2% profit remaining in this trade. So it would make sense to close this trade if we found another that has a 10% return over a comparable period.

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