Money Management When Selling Options: This is one topic I get the most questions and email about on this blog and the Time Farming newsletter. The question is, “How many commodity markets and how many options do you recommend I trade?” The short answer is: Probably three to six, and never let allow the margin requirements to exceed over 50% of your account balance.
When selling uncovered or “naked” options on commodities, the trader is required to have money in the account; this deposit is called the initial margin requirement. During the trade, the trader is often required to post additional margin called maintenance margin.
A margin in the futures market is the amount of cash an investor must put up to open an account to start trading.
This cash amount is the initial margin requirement and it is not a loan. It acts as a down payment on the underlying asset and helps ensure that both parties fulfill their obligations. Initial margin is a percentage of the purchase price of the underlying futures contact. For futures contracts, initial margin requirements are set by the exchange. Initial margin is sometimes called the initial margin requirement. In most cases, the initial margin requirement is 5–10% of the contract value. In commodities trading, your position is marked-to-market every day.
Maintenance Margin: If the account falls below this specified maintenance margin level, then the broker sends the trader a margin call, informing the trader that they must immediately deposit sufficient funds to bring the account back up to the initial margin level. If the trader fails to do so promptly, the broker will close out the trader’s market position.
Here is how to find the contract specifications and margin, a recent article on this blog : LINK
Money Management When Selling Options
Being able to hold a trade until you decide to exit is the goal. This is why the rule of thumb is to limit your margin requirements during all trading to between 25% and 50% of your account balance. For example: If your account cash value is $10,000, you should try and keep your total margin requirements near or below half that amount. Many readers email me and ask, “How many contracts of a trade should I trade?” This “50% rule” is why my answer is, “That depends on your account balance.”
In my subscriber-based newsletter, the TIME FARMING TRAINING BULLETIN – I share the details of the trades in my personal account, along with charts, comments, illustrations, and research. I furnish all the details by showing every trade in a quantity of one option(s) per trade. I do this because I want all traders from the smallest to largest to be able to compute their own number of positions easily to match their account size. A 14-day FREE trial is available HERE. (no debit or credit card required.)
It is quite normal to have trades in two, three, or more markets at the same time. This often means when your position in one market may be experiencing a drawdown (a reduction in account equity), the P/L is the other markets has enough profits to help your account balance stay below or near that 50% level of margin requirements. There is no doubt that larger accounts will likely be managed differently than much smaller accounts. If you are trading a $10,000 account and margin requirements exceed $5,000 you should immediately start considering how you might reduce margin requirements should you need to do so. Being forced out of a trade by getting a margin call is something you want to avoid at all costs.
Being at the 50% level does NOT mean you are in any immediate peril of a margin call. This is just a suggested level that you should start being concerned and watch it more closely.
This is why we suggest that smaller accounts observe the “200% Rule,” that states you should seriously consider exiting a trade when the premium on an option you sold has doubled. You can be a bit more lenient with short strangles because one side of the trade usually profits as the other side develops a loss; this helps offset some of the drawdown.
Fear and Greed are Account Killers
The tendency in human nature is to have a compulsion to hold losing trades too long. This reaction is so common – there is a term for it: The disposition effect is the tendency for an investor to take profits too quickly while holding on longer to losing trades. And holding the losers too long is just another way of saying the trader reverts to hope as a strategy. The point of this entire article is to reinforce how vital it is to preserve your trading capitol. I’m sure I won’t need to dwell on how important it is not to desensitize yourself to the folly of holding bad trades too long. This IS the #1 account-killer of all time, in all kinds of trading. Our human brains are very much hard-wired to find patterns everywhere; we evolved at the DNA level and our superior ability to adapt often works “too well” during trades. I’ve discussed some ways to cope with this in a previous article on the psychology of trading. read more here: https://sellingcommodityoptions.com/blog/psychology/
Being kind to yourself means learning how to use proper money-management in your account. Most of the options I sell have around a 95% chance of expiring worthless. Being able to exit some of those trades when necessary is an integral part of trading if you are to be successful. Read more about how to manage… STOP LOSS.
If you would like to learn more about how we use the Seasonal Patterns and Nobel-Winning Math to find Ultra-Low Delta / High Probability trades, please sign up for a FREE TRIAL of my newsletter, Option Income Training Bulletin.
Thank you and good trading to all. -Don