Why Risk Management is Critical
Risk management is the most important skill in options trading. Even the best traders lose money on individual trades - what separates successful traders is their ability to control losses and protect their capital for future opportunities.
Essential Risk Management Rules
Follow these rules to protect your trading capital
The 1-2% Rule
Never risk more than 1-2% of your total portfolio on a single options trade
Example: With a $10,000 account, risk no more than $100-200 per trade
Position Sizing
Start small and gradually increase position sizes as you gain experience
Example: Begin with 1 contract, then 2-3 contracts, before considering larger positions
Set Stop Losses
Decide your exit point before entering the trade
Example: If you buy an option for $2.00, consider selling if it drops to $1.00 (50% loss)
Time Decay Awareness
Understand how time affects your options value, especially in the final weeks
Example: Options lose value faster as expiration approaches - don't hold too long
Diversification
Don't put all your options trades in the same stock or sector
Example: Spread trades across different stocks, sectors, and timeframes
Common Beginner Mistakes to Avoid
❌ Buying OTM Options Close to Expiration
Why it's dangerous: These have very low probability of success and lose value rapidly
Solution: Focus on ATM or ITM options with 30+ days to expiration
❌ Not Having an Exit Plan
Why it's dangerous: Emotions take over when you're winning or losing money
Solution: Set profit targets and stop losses before entering the trade
❌ Revenge Trading
Why it's dangerous: Trying to make back losses quickly leads to bigger losses
Solution: Take breaks after losses and stick to your trading plan
❌ Ignoring Implied Volatility
Why it's dangerous: Buying expensive options (high IV) reduces profit potential
Solution: Learn to recognize when options are overpriced
Quick Risk Calculator
Calculate your maximum position size based on the 2% rule
Account Size
Max Risk (2%)
Max Contracts ($2 option)
Remember: These are maximum amounts - you can always risk less!
Exit Strategy Guidelines
Taking Profits
- • Consider taking profits at 25-50% gains
- • Don't get greedy - small consistent wins add up
- • Scale out of winning positions gradually
- • Consider the time remaining until expiration
Cutting Losses
- • Set stop loss at 50% of premium paid
- • Don't hold losing trades hoping for a comeback
- • Exit when your thesis is proven wrong
- • Avoid holding options in the final week