When is a trade too big for my account?

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).

toobig

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:

corn

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.

oil

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!

natgas

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.

Happy trading!

-J. Arthur

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6 comments on “When is a trade too big for my account?

  1. TNX Arthur,

    You write:

    “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 this case, the option is worth $2,431 and would give me pause for an account size less than $50K.”

    How do you come to this measure?
    What is the reason behind, to take this Put as the reference?
    How does it relate to a 3 x Loss?

    Thanks very much!
    Bratak

    Like

    • The 4% measure is a guideline I’ve come up with for myself through lots of experience. If the ATM put is worth more than $2K per $50K of account size, then I start having concerns that the product is too big or leveraged to trade.

      The 3 x loss is how much I am willing to lose on the trade.

      The problem is that sometimes we might jump into an underlying that has a lot more size and leverage than we realize, and a big move can make losses happen faster than we are able to react to. I try to gauge those products based on account size.

      Like

      • Thanks Arthur.

        I still don’t see the connections between the numbers/relations.

        So this measurement stems from your personal experience.
        It’s not like there is kinda math background to it to backtest it?

        However, thanks very much & keep up your work Arthur.

        Like

      • The ATM put is a good indicator of the relative size of risk of the product because that is what your short option will become priced at if it is getting breached.

        Often someone may sell an out of the money natural gas option and not realize that it is actually over 20 times the potential risk size of selling a corn option.

        Like

  2. PEDRO MIGUEL GUERRA

    Same Bratak questions below

    Like

  3. Pingback: How I’m tightening up my risk management. – Fire by Arthur

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