12 Minute Read

Options Theory: Size Matters

December 4, 2020

By | No Comments

You place four trades – three small, one big. You profit on three of them and are able to boast a 75% win rate. That’s good by any measure. Unfortunately, you didn’t make any money. Why? Well, because you won on the three small ones while losing on the single big one.

Such is the danger of inconsistent sizing. Varying the risk amount in each trade invites randomness to come to play. And he’s a nasty fella with a reputation of giving traders small gains while making them eat large losses.

It’s a recipe for meager returns at best and disaster at worst.

Call Me Cleo

One of the things I love about the Tackle Trading Journal is it tracks several key performance stats. Show me your win rate, average gain, and average loss, and I’ll tell you whether profits lie in your future.

Is it because I’m a fortune-teller schooled in the dark arts of divination? Nope. It’s because I know math.

No matter what your trading systems, the formula for profits is simple. The sum of your winners has to be larger than the sum of your losers.

  • If sum of winners > sum of losers then you’re profitable.
  • If sum of winners < sum of lowers then you’re not profitable.

There are three things you can do to increase your likelihood of success.

  1. First, increase your win rate. For instance, start winning 7 out of 10 trades instead of only 5 out of 10. This one is really hard, if not impossible. At a certain point, no matter your skill level, your improvement path will reach a plateau. All patterns fail, all traders suffer losers. Period.
  2. Second, increase your average gain. Even incremental increases can have a big impact. Maybe your average winner rises from $75 per trade to $85.
  3. Third, decrease your average loss.

Here’s an example of an account with over 300 trades in the sample. These were swing and position trades using options where I picked different symbols and strategies over time.

Note the key trade metrics up top.

  • Win Rate (aka percent profitable): 61%
  • Average Winning Trade: $70.29
  • Average Losing Trade: -$74.44

Keep in mind the ideal numbers vary depending on strategy. The majority of these options trades were high probability plays like naked puts and credit spreads which typically have an average loss that is 2x to even 3x the typical gain. With strategies like these, it’s impossible to get your average gain higher than your average loss.

In contrast, a stock trader should definitely shoot for having an average win far larger than their average loss. At the same time, the win rate would be lower.

If you haven’t created rules to ensure you’re consistent in the dollars risked for each position, then I highly recommend you do so.

Exceptions to the Rule

Let me conclude with a few scenarios where I could see someone deviating from this.

  1. First, if you are more comfortable or have a better track record with certain types of trades, then you might decide to risk a little more in them. I’m fine with that.
  2. Second, you might have some longer-term core positions such as long stock or covered calls, that require you to take more risk to avoid getting stopped out too quickly. I’m okay with that too.

I would just make sure the same types of trades have similar risk. My short-term swing trades all risk the same. My speculative debit or credit spreads all risk the same. My day trades all risk the same. You get the idea.

Trading Journals are essential for any successful trader. Click on the image to purchase our Trading Journals Bundle at a special price.

Tackle Trading Resources on Journaling

Continue learning about this powerful trading tool: the Trade Journals. Tackle Trading has all the resources you need to MASTER them like a PRO. From the Trade Journals themselves to free articles and tutorial videos on how to make the most out of them, we got you covered!

Trade Journaling for Beginners [Free Articles]


Read more Options Theory [FREE Content]

Every Thursday our resident options addict, Tyler Craig, will be at the helm to help you demystify derivatives and better understand what truly makes them tick. Options for beginners? Come this way, please. Enlightenment awaits.


Tackle Trading: Financial Freedom is a Journey. Sign up now for a 15-day free trial.

Financial freedom is a journey

Sign up now and gain unfettered access to all of the quality content and powerful Scouting Reports that our Pro Members enjoy for 15-days absolutely free with no strings attached and let us show you what your trading has been missing.


Legal Disclaimer

Tackle Trading LLC (“Tackle Trading”) is providing this website and any related materials, including newsletters, blog posts, videos, social media postings and any other communications (collectively, the “Materials”) on an “as-is” basis. This means that although Tackle Trading strives to make the information accurate, thorough and current, neither Tackle Trading nor the author(s) of the Materials or the moderators guarantee or warrant the Materials or accept liability for any damage, loss or expense arising from the use of the Materials, whether based in tort, contract, or otherwise. Tackle Trading is providing the Materials for educational purposes only. We are not providing legal, accounting, or financial advisory services, and this is not a solicitation or recommendation to buy or sell any stocks, options, or other financial instruments or investments. Examples that address specific assets, stocks, options or other financial instrument transactions are for illustrative purposes only and are not intended to represent specific trades or transactions that we have conducted. In fact, for the purpose of illustration, we may use examples that are different from or contrary to transactions we have conducted or positions we hold. Furthermore, this website and any information or training herein are not intended as a solicitation for any future relationship, business or otherwise, between the users and the moderators. No express or implied warranties are being made with respect to these services and products. By using the Materials, each user agrees to indemnify and hold Tackle Trading harmless from all losses, expenses and costs, including reasonable attorneys’ fees, arising out of or resulting from user’s use of the Materials. In no event shall Tackle Trading or the author(s) or moderators be liable for any direct, special, consequential or incidental damages arising out of or related to the Materials. If this limitation on damages is not enforceable in some states, the total amount of Tackle Trading’s liability to the user or others shall not exceed the amount paid by the user for such Materials.

All investing and trading in the securities market involves a high degree of risk. Any decisions to place trades in the financial markets, including trading in stocks, options or other financial instruments, is a personal decision that should only be made after conducting thorough independent research, including a personal risk and financial assessment, and prior consultation with the user’s investment, legal, tax and accounting advisers, to determine whether such trading or investment is appropriate for that user.

Chart Modal

Tackle Trading

Holiday Sale

Attention: Beginners and Advanced Traders!

The Annual Holiday Sale is here!

Celebrate the Holiday Season by taking advantage of this generous offer and save up to –60% on these awesome Trading Systems and Coaching Program!

Offer ends in

Days
Hours
Minutes
Seconds