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How much do you risk at selling future options?
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How much do you risk at selling future options?

  #1 (permalink)
Elite Member
Futures Experience: Intermediate
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Favorite Futures: short fut. opt., fut. spreads, div. stocks
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How much do you risk at selling future options?

Mu2pilot raised the question in the thread below regarding the profitability of selling options on futures and risk control. I think that topic, Money management & risk control regarding selling options on futures deserves its own thread.

CafeGrande gave some good advice but I havenít seen any money management strategies, so here is my attemptÖ

Letís say you have a trade account of $100,000 (just to give it some numbers to make it concrete).

And assume you have 90% winners (and so 10% losers).
I had a look at my own history and come up with these numbers (use your own if you like)
-Average premium per option $350
-Average days till exp. 136
-Average Initial Margin $1957, (I calculated that back to get your 2%/month)
-initial margin x2 = 3914$ (I use IB, feel free to do x3 for OX)

With an $100,000 and IM x2 of $3914 you can sell 100,000/3914 = 25 options in 136 days
In 1 year that is 25,5 * 365/136 = 68,6 (letís round to 68 options)

Now letís say you want to make 20% /year with above stats. (so with the 10% losers included)
So at the end of the year you need 20% x $100,000 = $20,000 profit (total $120,000)

Question is, how much can you let your losers run but still make that 20%?
So to make $20,000 with 90% winners of 68 options of each $350 gives:

[68(options) * 0,90 (90%win) * $350 ] Ė [68(options) * 0,1 (10% losers) * X] = $20,000
X = $209

So if you sell options at $350 you have to buy the loosers back at $350 + $209 to still make 20% at the end of the year.
(That is very little space to move and not even double!)
To play even (0 profit end of year) with these numbers you can each loser run to $3150
And if you are happy with 15%/year you can the looser run to $1313
I put it in a spreadsheet and tried some different inputs. See screenshot below.
The green cells are input, rest calculated. The red numbers I changed from the first group.
All scenarios with different %return/month.
Eg. first line is example above (difference is in rounding the options)

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The next step would be to calculate how many options you can have in that position without risking too much of your total portfolio. A lot has been written on money management so Iíll keep my version brief.

In the screenshot below the top group is a NGh14 call 7.0, sold for $150, with 55 days till expiration.
The red numbers are the total options sold in the position.
You can do the same calculation as above, and then add what happens if you only sold these options (the whole year). Obviously this is not realistic but its only purpose it so calculate the risk.
So if you sold 1 and you buy the looser back at $1358, that would also be your total loss which in its turn would be 1,358% of your total account (of $100,000) in my opinion an exactable loss.
If you sold 5 and lost, you would have a total loss of $6788 which is 6,79% of total, not sure if that is desirable.
And when you lost a position with 20, you would have lost 27% of your account.

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Purely mathematically, in a scenario where you win 90% you would have 10 consecutive losers in a row once in every 10 power10 trades, which is very unlikely. But still I would not be happy losing 10k on a 100k account.
The last number in the screenshot (% of account) I like to see below 10%, actually I prefer it to be below 4%.

The second group in the screenshot is an option further out (305 days), with 3% return/month and as you can see with less risk to total portfolio. (its the call NGZ14 9.0)

Thanks Mu2pilot for bringing this up.
I like to hear others if, (if I made any mistakes ) and if they use money management when selling future options and how.
Or what form of risk control you use.

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  #2 (permalink)
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  #3 (permalink)
Elite Member
Futures Experience: Intermediate
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Another way to look at it, more classic is the following.
Letís say you want a 3:1 return/risk ratio on selling a $350 option with a 90% win ratio.
Than you can have (for that option) a max loss of $350/3 = $117 and since you win 9 out of 10 times you can multiply that by (90/10) which makes $1053
Because in the long term you would win 9 times $350 and lose 1 time $1053 = $3150 / $1053 = 3:1

Than if you want to risk only 3% of your total portfolio (or 5% or 10%, what you like)
That would be a total risk of 3% of $100,000 = $3000
With a risk per option that would come down to $3000/$1053 = max. 2,85 options for this position
Loosing $3000 on a $100,000 account is only 3% and can be made back and still have a descend profit at the end of the year, but loosing 5% or 10% would be more difficult.

You could see what kind of initial margin is needed if the option went from $350 to ($350+$1053) to calculate the % gain.
Then take into account that it would only happen 10% of the time, and at what time it would happen (1day or last day)
And come up with some kind of formula between 1x initial margin and the margin needed if it went to ($350+$1053).

Problem with risking only 3% is that you can have 33 positions on at the same time which may not be possible in selling diverse options although the margin could be a limiting factor.

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  #4 (permalink)
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Chicago, Illinois
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First off, presupposing that you are right 90% of the time is a big presupposition. Are you basing that on the probability of expiring worthless or the probability of touching?

Also, I think that risk control is a misnomer. I think the strategy creates an illusion of risk control, much like someone who walks into the middle of traffic... just because you will be unscathed 99% of the time doesn't mean you are in control of the situation by any means. In the same vein, just because you are able to get out of a position that goes against you 99% of the time doesn't mean that the remaining 1% won't potentially bankrupt you. Selling futures contracts increases your exposure to black swan events to almost 100% in my personal opinion... because if this strategy works initially, you will have indefinitely have some type of short position in the markets. If there is a 99% chance of an option expiring worthless and you trade those type of options 100% of the time then it is only a matter of time until you encounter the 1% anomaly.

Just my opinion as someone who only trades long/hedged option strategies in the stock market

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  #5 (permalink)
Trading Apprentice
Detroit MI/USA
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Hi @crito,

I was also intrigued by m2pilot's post - I saw your thread afterwards. I posted my thoughts here:

I see two flaws with your calculations:
(1) 90% of trades are winners
(2) 20% yearly implies a 1.5% ROI compounded monthly (using the rate formula).

You will have a higher percentage of winners if you dont shoot for such high premiums (your ROI will be near the same since your IM will be significantly lower with further out of the strikes). This way you buy back the options earlier and increase ROI.

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