Why Manage Your Risk When Selling Options

Most people who enter the option selling world do so because it comes with a high probability of being correct.  Most people see that they can make money 80% of the time and decide that this is what they should be doing.

Few realize that even with such a high success rate you still should manage your risk.  Just being right 80% of the time isn’t going to make you an automatic Stock Market Trader.

Cases in Point look at iron condors.  An iron condor is a high probability trade but offers a risk to reward ratio that is very unfavorable.  For instance you may sell an iron condor between $400 and $300 and make a premium of $1.5.

It would be a high probability trade, because the stock only needs to stay between $300 and $400 for you to be profitable.  But say you are wrong, you may be risking $8.5 to make that $1.5.

Now let’s do the Math. If you are right 80% of the time and made $1.5 you would make $1.5*(.8) or $1.2 on average.  If you are wrong 20% of the time and lose an average of $8.5 when you are wrong you would lose $8.5*(.2) or $1.7 on average.

That means you would be losing an average of $1.7 - $1.2 or $.50 per trade if you just let it sit.   Now my goal isn’t to scare you away from the iron condor strategy, it is a very good strategy and can make you good money.

But you have to realize there is risk and it should be managed.   If instead we decided to cut our losses at a predetermined level, well that would help us lower our risk and tip the scale in our favor.  Cutting losses has to be at the front of your mind when trading.

Too many people focus on profits only and that is why they fail.

For more information about the iron condor visit http://www.stocks-simplified.com/iron_condor.html