Option Trading: Pricing and Volatility Strategies and Techniques

CHAPTER 13

Risk Management

You can’t be perfect, but if you don’t try you won’t be good enough.

—Paul Halmos, I Want to be a Mathematician (New York: Springer Verlag, 1985)

In preparing for battle I have always found that plans are useless, but planning is indispensable.

—General Dwight D. Eisenhower, quoted in “Krushchev,” in Six Crises by Richard Nixon (New York: Doubleday, 1962)

 

 

 

Many professional option traders find that making money is relatively easy, but keeping it is much harder (this is characteristic of any trader who makes money principally as a liquidity provider). As we state in Chapter 10, a “me, too” strategy in which we simply mimic the quotes of another trader can be very successful. As anyone can do this, there must be another aspect to option trading that has been overlooked so far; otherwise, every trader would be successful. This aspect is risk management. Most of what professional option traders do is risk management; playing defense and trying to keep money. If a market maker can manage to keep a third of the bid-ask spread, he will be very successful in the long run. The stress on risk containment is a key differentiator between amateurs and professionals.

There are two things to remember when putting risk management into context.

• Sometimes it is good to “take a shot” when making a trade. This could be for a number of reasons. You might want to start trading a new strategy. You may have a hunch that you simply cannot get the hard evidence to confirm. ...