The market has been a volatile beast over the past several months. Take a look at this past Thursday, for instance, if you need any more proof. Reducing risk is always a trader’s goal, but in these conditions it can be vitally important. One way to do this is by trading low risk trades with high potential rewards. But this can be difficult and tricky too. Low risk/high reward trades come with the trade-off of odds being against the trade, which can be frustrating. But there is another potential way to reduce risk, one that I always practice, but more so over this past March and April. And that is position sizing.

Position sizing is important for all traders. There are several risk/reward scenarios that are different from just buying or selling shares of stock. This can make position sizing a little trickier. As an option trader, I think you should consider at least different contract sizes depending on the trade and market conditions. Let’s take a look at three you might want to think about, especially in the volatile environment we have been trading in.

Full Size

I generally consider using a full-size contract portion when I deem the trade to be “money lying in a corner.” To me, that means the trade looks so good I feel confident it has potential to profit. One of the triggers for this type of trade, for example, would be having a bullish bias on a stock as well as the overall market. Another would be a time spread with an IV skew that cannot be ignored. Whatever full size means to you (for this example let’s use 10 contracts), this is where I might put on a trade with 10 contracts.

Half Size

If 10 contracts are full size, then 5 contracts are half size. To me, these are trades that look good, but maybe the market is jittery, or I am considering a bearish trade idea and the market looks like it wants to head north. Of course, if the market does move higher, that does not mean my stock will not move lower, but there is some concern. Since I personally trade fewer OTM (out-of-the-money) vertical credits than debit spreads, I might use half size for an OTM credit spread.

Nibble Size

To me a nibble size is taking a little extra speculative shot at a trade. For example, maybe I am looking for a move over a resistance area for a bullish trade opportunity and the stock has not yet cleared that level, but I think it will eventually do so. Here is a spot where I might just put on 2 or 3 contracts to “test the water.” In other words, I am waiting for confirmation but have not yet received it. Another time I might do a nibble-size portion is with a speculative trade that has low risk and high reward.

The overall market needs to be a big part of the equation on how many contracts you will trade. Consider combing this with the risk/reward the trade has given you (if defined). As always, if you think of yourself as a risk manager first, you have crossed a major positive hurdle as a trader.

John Kmiecik, Market Taker Mentoring