3 Step Formula To Easily Figure Out How Many Options Contracts You Can Trade

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It's fairly easy to blow up your trading account. . .

Too often, traders (both advanced and beginner) allocate way too much to a single trade.

They think that because they have a "smaller" account that they need to up the risk and leverage to make money "faster".

What a stupid mentality. . .and I want to show you how to figure easily out how to calculate your appropriate contract size.

And lucky for you it's only three steps.

Step 1: Determine Your % Risk Per Trade

In my options, this is the best way to manage risk size and the number of contracts. Historically called fixed fractional risk.

For example, you might risk 2% of your account equity on each trade. If you have an account of $50,000, this would mean that no more than $1,000 of risk ($50,000 X 2%) would be allowed per trade.

Personally, I wouldn't go any higher than 5-7% per trade even if you are just starting out!

If you cannot learn to trade small positions profitably from the beginning then how will you ever learn to trade a larger account later on?

Sure commissions have an effect on your trading, but you can factor them in according to your situation.

Step 2: Determine Your $ Risk/Contract

The next part is to take the individual trade you are looking at and determine what the max risk is for that trade or strategy.

If you are trading a long Call/Put, this would be your premium paid. For vertical spreads, it's the difference in the strike prices less the credit received.

For example, you are trading a SPY 175/170 Put Spread and take in a credit of $100. The difference in strikes is 5 points or $500 less your credit of $100, so the max risk is $400 per spread.

This is the one lot spread risk per the contract we'll need below. . .

Step 3: Divide % Trade Allocation by $ Risk/Contract

With both of the figures from above we simply divide the max percentage allocation per trade from #1 by the risk per contract from #2.

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$1,000 max risk per trade / $400 max risk per contract = 2.5 contracts

Easy right!? Now you know that based on your portfolio and risk tolerance you can trade at most 2.5 vertical spreads on SPY.

You can round up or down as you wish, but at least you have a better guideline to use instead of guessing.

Next Steps. . .

Managing this key aspect of risk can make all the difference in the world in your ability to trade options for income each month.

Remember this is just 1 example using a Vertical Put Spread. If you have questions about how to calculate your risk per contract on other strategies like Iron Condors, just add them to the comment section below.

About The Author

Kirk Du Plessis

Kirk founded Option Alpha in early 2007 and currently serves as the Head Trader. Formerly an Investment Banker in the Mergers and Acquisitions Group for Deutsche Bank in New York and REIT Analyst for BB&T Capital Markets in Washington D.C., he’s a Full-time Options Trader and Real Estate Investor.

He’s been interviewed on dozens of investing websites/podcasts and he’s been seen in Barron’s Magazine, SmartMoney, and various other financial publications. Kirk currently lives in Pennsylvania (USA) with his beautiful wife and two daughters.

  • The Lazy Trader

    Nice article. Kirk what about income trades (Iron Condors, Out of the Money Credit spreads) where the trader won’t let the worst case scenario happen? and will cut the losses or adjust the trade sooner? Wouldn’t you allocate more capital based on the fact that you know you will never risk your max loss scenario?

    • But how can you guarantee that won’t happen? What if the stock jumps/falls on some company news you didn’t know was coming out. This risk is less on ETF’s and bigger names but it’s still there.

      • The Lazy Trader

        I can understand that. But for example if you were to open a position (credit spread or Iron Condor) in an index for example, where you are risking 9 to make 1 (around 90% probability of success). If you only use 5% of your capital, the max profit potential would be a ninth of that 0.55%, and you would have to deduct commissions afterwards. That’s why I argue, maybe it makes sense to use 10% – 15% of your margin in one of these trades, knowing that 1- you are trading an index and 2- you won’t let the trade get to its worst loss. Other than that, yes, totally agree with your opinion. You dont know what will happen to a stock after hours or in other unexpected events. And losing 5% of the portfolio in one single trade is a risky style.
        Thanks for the article!

      • I disagree to use that much in capital but then again everyone can adjust as they see fit. It also depends on how high your commissions are.

  • Vin

    Very useful formula for money management in trading options. Thanks Kirk

    Chuong trinh lop hoc quyen chon

    • Hey Vin! Glad you found it helpful! What other topics around options trading would you like to see?

      • PCaliTrades

        Great article. More often than not, I see new traders putting up 50% +/- of their account on any given trade (shooting for that home run). Sometimes it gets worse when they are trying to get revenge on a previous trade. This is a solid guideline for any trader, no matter the account size, to consider. I will definitely share this with some people. Thanks.

      • Yep revenge is dangerous and home runs are far and few between. Thanks for passing in along PCaliTrades!

  • elkate

    Hi Kirk, thanks, great article, how would you calculate position size on iron condors, diagonals, and calenders. Sorry to put all of them together in one question but don’t want to waste the real estate here.

  • Hard to calculate a firm number on those because the margin is variable. I tend to do less overall naked positions in general and still stick to the margin per risk as I talked about above.

  • I do think it’s worth the attempt even if it takes a while to grow your account. Honestly I find that those who are able to manage smaller accounts will do better long term. If you can’t profitably manage a 20k account it’s not getting any easier to do it with a 50k account. Thanks for the feedback!!!

  • Jeremy

    I know old discussion – but just ran into it today. I have wondered about how much I should risk each trade so thanks for the discussion. I ran across this trying to answer another question – what do yo think kirk? Here is the question. if you Decide to risk 2% using vertical spreads – does it make a difference (which is a better strategy) to take more contracts with a smaller spread, or larger spread with less contracts?

    For example (using your example of SPY) – and assume the math works out – would it be better to do a bull put spread 209/210 and take 5 contracts or a 205/210 with 1 contract – and the credit is $100 on each, and the risk is $400? Would it make a difference (ignoring the extra for premiums)?

    • Larger spread with less contracts always is favorable if you can do it because it means less commissions :)