Options Risk Management

Sustainable trading isn't about making wild guesses—it's about playing defense. By setting up strict rules for your portfolio, you turn unpredictable market moves into steady, mathematical probabilities.

1. How Much to Risk (Position Sizing)

Before you enter any trade, you need a plan to protect your overall account from a single bad stock.

Core Protection Rules

  • The 1% to 5% Rule: Never put more than 1% to 5% of your total account cash into any single trade or company.
  • Know Your Worst-Case Scenario: Always check your true margin impact and maximum possible loss before entering a trade.
  • Don't Overcluster: Avoid loading up heavily on stocks in the same industry (like buying 5 different tech stocks at once), which creates hidden risk.
  • Fear the VIX: When the market gets highly volatile (the VIX index goes above 25), cut back on how much leverage you use.

Real-World Example

Example ($100,000 Account): If you set a strict 2% risk limit per trade, you should never be exposed to losing more than $2,000 on a single stock position.

Essential:

2. When and How to "Roll" Trades

"Rolling" just means closing your current option contract and opening a new one further out in time. It buys you more time to let the trade work out.

When to Take Action

  • Take Profits Early: Don't get greedy. When you hit 50% of your maximum possible profit with over a week until expiration, close the trade and redeploy the capital elsewhere. Remember, having cash is always a position.
  • Watch the Delta: If a trade moves against you and your Delta climbs from a safe ~0.30 toward a riskier 0.45 or 0.50, it’s time to act defensively.
  • Don't Wait Until It's Too Late: Make your adjustments before the stock price blows completely past your strike price.

How to Roll

The Horizontal Roll (Roll Out):

Close your current option and sell the exact same strike price on a later expiration date. This buys you time without changing your target price.

The Diagonal Roll (Out and Away):

Close your current option, pick a later expiration date, and move your strike price further away from the danger zone.

Rolling examples

Review rolling rules strategies:

3. What to Do on Option Assignment

Getting assigned means you are forced to fulfill the contract (buying or selling the stock). This is a normal part of options trading, not a failure. Always have a plan in case of assignment.

If Your Put Option is Assigned

  • The Trigger: The stock price falls below your strike price at expiration, forcing you to buy 100 shares of the stock.
  • Now What: Turn it into an income generator. Immediately start selling Covered Calls against those new shares to collect premium. Always double-check that you actually want to own the underlying. If not, close it for a lost and move on.

If Your Call Option is Assigned

  • The Trigger: The stock price rises above your strike price at expiration, forcing you to sell your 100 shares.
  • Now What: Take your maximum profit and walk away. Your capital is now free, so you can restart the cycle by selling a Cash Secured Put.
The Golden Rule: Never sell an option contract unless you already know exactly what you will do if assignment occurs.
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