There are two rules for
ultimate success in life:
(1) Never tell everything
you know.
Position Sizing
by PJ Scardino
The purpose of any trading system is to:
Minimize risk
Maximize reward
& not let your emotions get in the way
Money Management
or
how to control risk
 Position Sizing determines how much
you can win or lose on any given trade.
 Use Reward to Risk (RR) ratios
to maximize your gains
 This is the 1st step to having a
successful trading system!
RR Example:
 Your risk is $1
your expected gain is $3
then Reward vs Risk = 3 to 1
also shown as 3:1 or just RR=3
 Note: Given RR=3 and
if your win 4 out of 10 trades then overall return is 20%
It’s also 20% if RR = 2 and wins = 6 out of 10
Defining Risk
 Know your exit targets before you enter
the trade (stop loss & profit objective)
 You buy a stock for $20
your stop is $15
Your objective is $30
 Then the potential Reward is $10
& the potential Risk is $5. RR = 2
How can we do this
with options?
 You could just set the stop and profit
objectives on the option or …
 Using your favorite tool (Technical,
Fundamental, Sentiment, or Ouigi board)
Define stop and profit price points for the
stock and calculate the option prices for
the stock at those levels.
 Then compute RR for each option you
are interested in. Here’s an example …
QCOM 12/31/03
eSignal Advanced Chart
Wave 5 top, confirmed by Oscillator divergence. Minimum retracement target
identified by Ellipse. Price objective is previous Wave 4.
QCOM 12/31/03
OptionVue Chart
The blue outline in the upper right corner is the projected price and time.
QCOM analysis
 We expect the price to fall and fill the gap left
at 46.10 (roughly in the area of the previous wave 4)
 If price exceeds 54.90 then
our current analysis is wrong.
 At a minimum price should retrace to the
ellipse at 52.08 (which is also the middle of the Bollinger Band)
 This should happen in the next 2-6 weeks
Options Matrix for QCOM 12/31/03
Which Option would you buy?
Here’s what Trade Finder came up with:
Capital provided
is $5000.
$5000 not our real risk!
 Worst case the stock reaches our stop and we
exit the option position.
$54.90 in 39 days
 Maximum gain occurs if the stock reaches the
target price in the minimum number of days.
$46.10 in 13 days
 Minimum gain occurs if the stock reaches the
minimum price in the maximum number of days.
$52.80 in 39 days
Risk graph for Feb 50 put
Stock =$52 Option = .60
(39 days)
Stock =$55 Option = .20
Risk graph for Feb 50 put
Stock =$46 Option = 4.80
(13 days)
RR = 3
 Initial price of Feb 50 put = 1.35
 If we reach our stop in 39 days
Stock = 54.90 then Feb 50 put = .20
Risk = (1.35 - .20) = 1.15
 Note that if only the minimum target of 52.08
is reached the option is only worth .60
which would actually be a loss not a profit!
 If we reach our target in 13 days
Stock = 46.10 the Feb 50 put = 4.80
Reward = (4.80-1.35) = $3.45
Position Size
 If we are going to risk $5000
we will buy 43 contracts at $1.35
( the risk per contract is $1.15 )
 This would require $5805 of capital
(not including commissions)
 We are actually risking 86% of the capital
Questions to answer:
 Does the contract have enough liquidity?
 Is the capital requirement too large?
 Is this the best RR we can get?
 What about an OTM option or
a contract with more time?
QCOM Apr 55 put
Position Size for Apr 55
 We can buy the Apr 55 put for $4.60
 The risk per contract is $1.30
 We can risk $5000 but let’s say we only
have $10,000 of capital available so …
 All we can buy is 22 contracts
making our risk just $2860
 Note: we are only risking 28% of the capital!
An Excel worksheet will do much of the work.
Account Info
 1st step is to enter your
account info
 Row 2 establishes the
max risk as 5% of the
account
 Row 4 insures the size
of the trade does not
exceed available cash
or a 10 % of account
Fields in Blue can be changed by the user
Step 2: The Option info
 After entering the option as
month, strike and expire -the symbol will be created
and if you have eSignal the
current price will be
calculated
 For each option enter the
value for
Stop
Min Target
Max Target
 Enter Target Range in
E11:F12
The Results:
 RR and Pos Sz are displayed for each option.
 Also shown are values for Risk, Reward, Gain, Actual Cost, OI
(open Interest) and Volume
 Observe the Feb/Apr 60 puts have the highest RR but
 The red S and V indicate an open interest / volume alert
 The Apr 55 put has RR=3.9 and enough OI and volume
Any Questions?
If you would like a copy of the presentation
or the Excel spreadsheet send an email to:
[email protected]
Give me the courage to pull the trigger
when the market has changed;
Give me the strength to hold my ground when it hasn’t;
And give me the wisdom to know the difference!
SMH – Semi hldrs
SMH – Semi hldrs
SMH – Semi hldrs
Follow-up on QCOM, SMH
1/7 QCOM stop triggered, Apr 55p at 3.80 loss = .80
1/8 SMH target reached. Jan 40c gain of 1.85