How many option contracts do you trade? I just had this discussion with one of my students the other day. I was a little shocked to hear that he trades the same number of contracts (10 in case you were wondering) every single time. It did not matter what the strategy was or what the market conditions were; he always did 10. As you have probably noticed, the market has been fairly volatile and unpredictable with Covid and inflation concerns running a bit rampant.

Multiple Contract Sizes

To me, using varied contract sizes for different strategies and market conditions makes sense. As you probably know, option trading has various risk/reward and probability scenarios. For example, I may not want to do as many contracts on a higher risk and lower reward strategy. On the contrary, a lower risk and higher reward trade may warrant a bigger contract size. Below I share my thoughts on varying contract sizes.

Full Size

Full contract size can be whatever you want it to be based on your experience and comfort level in addition to your account size. I generally consider using a full-size contract portion when I deem the trade to be “money lying in a corner.” What I mean is that the trade looks so good I am confident of its potential to profit. In other words, I feel I have my ducks in a row. One of the triggers for this type of trade, for example, would be having a bullish bias on a stock and the overall market as well. Or for a time spread, an IV skew that cannot be ignored. Whatever full size means to you, this is where I might put on a trade with that number of contracts.

Half Size

If we were to say 10 contracts is full size, then five contracts obviously would be half size. To me, these are trades that look good, but maybe I view the market as jittery (as it has been lately) 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 out-of-the-money (OTM) vertical credits than debit spreads, I might use half size for an OTM credit spread because the risk/reward is not good compared with some other strategies.

Nibble Size

To me a nibble-size contract size is when you take an 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. Here is a situation where I might just put on two or three contracts to “test the water.” In other words, I am waiting for confirmation but have not received it yet. Of course, no option trader should continually take “gut feeling” trades, but this is the contract size I use when I allow myself to do so. Another time I might do a nibble-size portion is with a speculative trade that has low risk and high reward like an OTM long call or put.

Finally

Of course, it is not mandatory to use different contract sizes in your option trading. But I think if you do, you will become a better risk manager than if you were to use the same contract size for every transaction. And being a smart risk manager is what we all need to strive to be as traders.

John Kmiecik, Market Taker Mentoring