For anyone new to options investing, the first thing one must learn is money management.
When I say “money management,” I don’t mean balancing the checkbook or checking on the account balance.
In options investing, money management refers to the strategies and practices used to control risk and keep the account within the safe zone.
It’s a crucial part of successful options trading because of the leverage and volatility involved with options.
Money management is a balancing act because it aims to preserve capital while simultaneously optimizing returns.
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There are four money management metrics to take into consideration:
- Cash Reserve
- Number of positions
- Account size
- Position size
I typically aim to keep around 30% in cash, especially in more volatile markets.
This helps reduce drawdowns and gives you flexibility if new opportunities arise or adjustments are needed.
As a newer options trader, depending on your risk tolerance and account size, you may want to keep a larger percentage of the account in cash.
That way, you can become comfortable with trading options before deploying more capital into the market.
Even experienced options traders will tend not to use more than 70% of their accounts in option trades.
They have seen what happens in unexpected market events.
They know that the larger the amount of cash they have in reserve, the smaller the impact of such market events.
Starting with 5 to 10 trades is sensible.
As you gain comfort, 15 to 20 is manageable for most traders, especially with high-probability strategies that don’t require constant adjustment.
Beyond 20, it becomes harder to track risk and exposure efficiently.
Thirty positions would be about max once you have 6 to 12 months of experience.
An account size of $5,000 to $10,000 is a realistic starting point for basic spreads.
That said, more capital provides more flexibility, especially with diversified trades and scaling.
You would need close to $100,000 to do the Wheel, for example.
I’ve found that things start to feel smoother operationally from around $150k to $250k account size.
That’s the level where you can build a diversified income-focused options portfolio and not be overly exposed to a single trade.
Once you get above that level, you can start to have $2,000 to $3,000 daily profit and loss (P&L) swings, which is harder to handle emotionally.
A general rule would be to risk no more than 5% of your portfolio for any one trade or stock.
As your account grows, yes, you would increase your position size per trade but try to keep within the overall guidelines.
I like to focus more on portfolio risk because the risk of a bullish trade is partially mitigated by another bearish trade in the portfolio.
Delta dollars are a way to normalize risk exposure across trades.
Let’s take an example portfolio with the following bull put credit spreads with the position delta of the position shown.
Price of AXP: $294.05 per share
Sell one July 3rd AXP $295 put
Buy one July 3rd AXP $290 put
Delta: 7.95
Delta Dollars: $2,337
Max risk: $300
Price of GDX: $50.65 per share
Sell one July 3rd GDX $50 put
Buy one July 3rd GDX $45 put
Delta: 29.74
Delta Dollars: $1,506
Max risk: $350
Price of MO: $60.95 per share
Sell one June 27 MO $60 put
Buy one June 27 MO $55 put
Delta: 32.51
Delta Dollars: $1981
Max risk: $300
Price of SOFI: $13.26 per share
Sell one June 27 SOFI $15 put
Buy one June 27 SOFI $10 put
Delta: 94.42
Delta Dollars: $1,252
Max risk: $275
Price of TSLA: $345.60 per share
Sell one July 3rd TSLA $365 put
Buy one July 3rd TSLA $360 put
Delta: 2.83
Delta Dollars: $978
Max risk: $240
The portfolio contains the following bear call credit spreads.
Price of IBB: $121.72 per share
Sell one June 20 IBB $120 call
Buy one June 20 IBB $125 call
Delta: -25.25
Delta Dollars: -$3,073
Max risk: $250
Price of PEP: $131.50 per share
Sell one June 27 PEP $140 call
Buy one June 27 PEP $135 call
Delta: -18.48
Delta Dollars: -$2,430
Max risk: $375
Price of TGT: $94.01 per share
Sell one July 3rd TGT $95 call
Buy one July 3rd TGT $100 call
Delta: -18.76
Delta Dollars: -$1,764
Max risk: $300
There are five bullish positions and three bearish positions.
Having eight positions at the same time is a manageable number – not too many, but enough for diversification.
Because these are defined-risk trades, each trade has a max risk of about $250 to $375.
It is good that their max risk is within about the same ballpark in dollar value.
In a $10,000 account size, each trade represents about 2.5% to 4% of the portfolio – which is less than the 5% maximum per trade.
If you aggregate the maximum risk of all the trades, it comes out to be $2,390.
So, the options positions are using up about 25% of the portfolio with 75% in cash reserves.
This is fine if you are starting out.
You can increase your capital usage as you become more consistent in your wins.
The position delta of the trade will tell you how bullish or bearish the position is.
If it is positive, the position is bullish.
If it is negative, the position is bearish.
However, the numeric value of the position delta depends on the size of the underlying.
Hence, you can not compare the delta of SOFI with the delta of AXP.
You might think that because SOFI has a delta of 94.42 while AXP has a delta of 7.95, SOFI presents a much bigger directional risk than AXP.
However, that is not the case.
A 94.42 delta on SOFI means that the bull put spread acts as if an investor owns 94.42 shares of SOFI.
A $1 move in SOFI means a P&L increase of $94.42.
A 7.95 delta on an AXP bull put spread is like owning 7.95 shares of AXP.
A $1 move in AXP results in a profit of $7.95.
However, it is more likely for a $1 move to happen in AXP than a $1 move in SOFI simply because the size of AXP is so much larger than SOFI.
A $1 move in SOFI is a 7.5% move in the stock.
A $1 move in AXP is a 0.34% move in the stock.
A $1 move in SOFI is equivalent to a $22 move in AXP, as both represent a 7.5% change in the stock price.
If such a move occurred, SOFI would profit by $94.42, and AXP would profit by 22 x $7.95 = $175.
The AXP position is more bullish than SOFI, regardless of its position delta.
This is why position deltas are not comparable across different underlying assets.
A 94.42 delta on SOFI can not be compared with a 7.95 delta on AXP.
Delta dollars are used instead because they are comparable across different underlyings.
It takes into account the size of the underlying.
Delta dollars shown above for each of the trades is simply the position delta multiplied by the price per share of the stock.
The delta dollar for SOFI is $1,252.
The delta dollar for AXP is $2,337.
AXP has a larger market exposure. It is a bigger position.
And it is more bullish than SOFI.
Recall that a position delta of 94.42 for SOFI is equivalent to owning 94.42 shares of SOFI.
This means that 94.42 shares of SOFI represent $1,252 of market exposure, as one share of SOFI is currently priced at $13.26 per share.
Similarly, AXP at $294.05 per share and a position delta of 7.95 has a market exposure of $2,337 (because $294.05 x 7.95 = $2,337).
These numbers are the same number as the computed delta dollars.
You now can see that the delta dollar represents the market exposure of the position.
We have both bullish and bearish market exposure in our positions, as represented by positive and negative delta dollars.
If we aggregate all the delta dollars of all the positions, we get a portfolio delta dollar of $788.
The portfolio is slightly bullish.
But not by much.
A market exposure of $788 in a $10,000 account is only 8% – well within acceptable risk.
Now you understand how delta dollars are used to understand portfolio risk.
Some trading platforms will calculate this for you.
Or you can manually calculate.
Other platforms may give you beta-weighted delta, which is a similar concept for understanding portfolio risk.
Regardless, understanding portfolio risk is a crucial first step for new options investors.
We hope you enjoyed this article on four essential money management metrics for new options investors.
If you have any questions, send an email or leave a comment below.
Trade safe!
Disclaimer: The information above is for educational purposes only and should not be treated as investment advice. The strategy presented would not be suitable for investors who are not familiar with exchange traded options. Any readers interested in this strategy should do their own research and seek advice from a licensed financial adviser.
