Some trading products are highly leveraged or just plain huge; futures contracts can be a good example of this. So how do I know if a trade is too big?
My primary rule of thumb is that I look at the credit I will receive for my strangle and know that I will close the trade if it hits a loss of 3 times that initial credit. I should be fine with taking that amount of loss on a trade.
But sometimes a product itself can be huge and an outlier move can change the value of the options much faster than expected. This can especially be confusing with futures, as they are not standardized like equity options. Notional value may also be misleading because it does not take into account the viable range for the underlying.
So what do I do? I look at the at-the-money put of the closest expiration to 150 DTE (but still under 150 DTE).
If the value of that option is more than 4% of my account value, I become hesitant to sell a strangle on the underlying. In the British Pound example above, the option is worth $2,431 and would give me pause for an account size less than $50K.
Now if I look at corn, the story is different:
With corn, I’m seeing an ATM put for $375 in the expiration I would trade. I would certainly sell a strangle unless my account size were under $10K.
In comparison, oil futures are huge.
That’s $4,980 for the ATM put. It’s good to have a feel for the size of the product.
And natural gas futures are massive! $9,840 for the ATM put!
So that is how I put context around the size of the futures products, because not all of them are behemoths. But some are, and this is how I gauge it.
Again, no part of this blog is a recommendation to enter a trade. I am sharing my own trading experiences for learning and entertainment.