If the Risk is Worth Taking, Do it and Manage the Risk

Airplane

02 Feb If the Risk is Worth Taking, Do it and Manage the Risk

Thank you for all the encouragements and well wishes after I made a big loss in trading.

While most people understand why I lost money and the message of the article, there is a handful of readers who thought that I lost money because selling naked options is risky.

I would like to write this article to reiterate my message as it is important readers get it.

Is Air Travel Risky?

Ever since air travel was made possible, people had the fear about airplanes falling off the skies. Even though some of us still hold that perception that air travel is risky, statistics have shown that AIR TRAVEL IS NOW SAFER THAN DRIVING A CAR:

We know that trying to pick stocks can be very frustrating. Skip that frustration, get 21 ideas to finding profitable stocks in an instant. 

If the risk is worth taking, do it but manage the risk

When something is risky, it does not mean we do not do it. In fact, knowingly or unknowingly, we take risks everyday. There is risk crossing a road. There is risk taking a bus. There is risk eating in a restaurant. There is risk when we exercise. It is impossible not to take any risk in a day.

The more important question is, “Is the Risk worth taking?”

The answer is yes to air travel because it will take a long time to travel by road or sea to visit a faraway country. Air travel has improved business efficiency and brought many people to see different parts of the world.

The second question is, “If the Risk is worth taking, how do we manage it?”

The airline answered that question and brought accidents under control. Risks associated with a dangerous endeavour can be managed to a safe level.

No entrepreneurship?

Starting business is risky too. But it is definitely worth doing, at least at the societal level. If everybody has an employee mindset because we all want to avoid risks, who is going to employ us?

Hence, taking and managing risks are part and parcel of businesses and capitalism.

There was a scene from the movie, Margin Call. The CEO called the principals for an emergency meeting because the company may go bankrupt with all the excessive risks it was taking. The CEO educated a junior analyst why he gets paid more by sitting around in meetings to make decisions – the CEO’s sole role was to keep the company alive to make money. In pure sense, risk taking and management.

Is Stock Picking worth the Risk?

Stock picking is hard. Most funds cannot beat the index. Most retail investors cannot even get positive returns. Why are we still trying to do it? Why not just invest in index funds?

This is because stock picking is worth it. When we get it right, it gives us an extra few percentages more than an index fund returns, and this can mean millions of dollars over a long period of time, depending on the capital and investment time-frame.

Is Selling Options worth the Risk?

Yes (to me), because I can potentially make 3% return on capital per month, or 42% per year. However, it is not possible to make money every month because the market may over-react to certain events and an option trader can suffer losses that eat into the profits. The trader’s role is to protect the capital as much as possible during these events, and probably achieving 20% per year seems more reasonable.

Let me reiterate my message – all forms of trading are risky. You are learning the wrong lesson if you think that trading other stuffs (stocks, forex, futures, CFDs) are safer than options. My mistakes were over-leveraging and not cutting loss. Applying both these mistakes to other trading products will result in blow ups too! It is not just the product, it is how the trader approach and manage the risks that matters more.

A trader who trades forex who doesn’t cut loss isn’t ‘safer’ than a trader selling options who cuts losses.

Stick to Passive Investing if the risk is not worthwhile for you to take



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19 Comments
  • coconut
    Posted at 10:16h, 02 February Reply

    i cannot agree more.

    many say stocks are the most safe vehicle but i think more people lost in stock trading than any other form of investment. whereas traders know of the leverage in future and fx trading they tend to be more careful.

    alvin, your risk manegement, in my opinion are where off the chart, meaning you took where too much risk, you are lucky you lost only 100k, it can be worst. throughout your trading life, it only need one event that will wipe you out completely.

    • Alvin Chow
      Posted at 10:26h, 02 February Reply

      Yes coconut. I paid a price to re-learn risk management.

      I definitely need to have stricter measures in place.

      Request my broker to lower the amount of margin.

      Buy a further out-of-money option to limit the loss and forgo some premium.

      Do you have other suggestions to improve risk control?

      • coconut
        Posted at 10:51h, 02 February Reply

        oh no! i will ask my broker to increase the margin rather than reduce!!!

        like you say, you have over trade your position, where over trade and not hedged, reduce your margin will only mislead you into believe you are taking less risk.

        there is nothing wrong with selling option, just like an outright long or short position, its your position size you need to be watching, and your strategy to reduce that risk exposure, for example hedging or spread, in option trading, there are many you can learn how to hedge. hedging is also very subjective and relative, you still have to watch your risk fluatuation (through market movement) even when you think you are fully hedged.

        last, don’t ever use money as a guide to determine your trades, like i must make x amount of money each day/week/month/year, just becos thats what you are making working or for a living. thats very dangerous!!!! never looks your money for trading in terms of any thing except as a percentage bet againtst your equity, period!

        • Alvin Chow
          Posted at 11:05h, 02 February Reply

          What I mean is to use reduce the leverage. I think I wasn’t clear using the word “margin”. I want the broker to lock half of my capital, only using the other half available for trading.

          I committed the mistake you last mentioned. I was too anxious to make a fixed sum of money per month. I expect the market to be consistent. Which is wishful thinking. I have to be the one consistently controlling the risks.

          • coconut
            Posted at 11:32h, 02 February

            ya, the best way is you have to realise and do the control yourself rather than a third party. i never let margin (call) play any part in my trading, through out times there were many margin revision that the broker did due to volatility, i never read them. in fact i think revision may had help me a bit when ever there is an increase!

            sometimes i’m not sure i can gives you a good advise cos i’m very conservative and my risk management is so regid that i forgo many profit opportunity. it really depends of a person appitite for risk exposure and modify your strategy accordingly.

  • coconut
    Posted at 10:33h, 02 February Reply

    and one more very important point, my point of view, you trade, you also invest, thats means you are both a trader and a investor. how can you manage, from money management point of view, to effieciently manage your risk?

    from my sole opinion, trading and investing are 2 very different aminal, they are very much contracdicting, i can manage my trade very well but it screw up my investing principle and visi versa. its like chinese saying, fish and bear craw, you can only choose one (or manage one well).

    that beings said, i think its better for a person either go for investing or pure trading, you will do well in one area and not both, more likely they going to screw up in both area.

    • Alvin Chow
      Posted at 11:01h, 02 February Reply

      I know what you mean. Sometimes I contemplate whether I should just stick to one and stop having a split personality! Haha.

      What I did was to segregate the markets and time-frame. I invest in Singapore stocks and trade options on futures.

      The recent big loss let me consider this seriously.

    • coconut
      Posted at 11:15h, 02 February Reply

      so in your case, lets say you have not really over trade, and you have what? 4 accounts, your equity spread all over the place and say in property too.

      now, your option position are in trouble, you need more margin to hold your positions, how?

      again, your position are not that big, you still can salvage your position without cutting the position size, but becos your equity are all over the place, how are you going to do that? you know many a times, when you are forcing to cut back, thats where the market are turning and you should have not lost that trade. so apart from bad trades due to where where over trade, you also have a serous money management problem.

      i might be wrong and yet to be tested, but i can tell you that for this reason, i did not put any of my funds into any investing vichicles except for trading. i want to be 100% sure i have the equity i needed when times comes. in this aspect, you should think very careful before you jump into conclusion with me cos in involve all aspect in your life.

      • Alvin Chow
        Posted at 11:29h, 02 February Reply

        thanks coconut, this is a very insightful sharing.

        actually putting money across different accounts was a safety net for myself. in case that I underperform in one or two accounts.

        because of this insecurity, which was disguised as a form of safety, result in excessive risk taking – my subconscious mind think that I have other accounts so it doesn’t matter I can blow this one account up.

        you are right that I will have enough equity to survive the trade if all my capital is in options.

        hmmm… I seriously need to think about this.

        • coconut
          Posted at 11:45h, 02 February Reply

          please be careful in your consideration. its no laughing matters!

          putting everything into trading can easily get wipe out pretty fast! unless you are like me, beside trading, i don’t want to do any other things or be any other person! i rather be broke!

          do it when you have developed a strategy that you are very confident it will make you a winner in the long run only!

          mean time i suggest you trade only 1 or 2 lots, no, 1 lot will do, at one time until you found something you can test on.

          few months ago, i teach my friend how to trade spread trading, starting from a position size that just enough to cover commission when the spread is covered! he gave up haha….

          • Alvin Chow
            Posted at 11:59h, 02 February

            yes coconut, I need to consider it carefully.

            there are a lot more things I want to do in life other than trading.

            I must also consider my strengths and personality, in which aspect I will have more edge and a higher interest.

            I will also give up if I were your friend. it led me thinking whether I am trading because I like it or I am doing it for money, which I know it is not going to do me good if it is the latter.

  • Patrick Lee
    Posted at 12:36h, 02 February Reply

    “It is not just the product, it is how the trader approach and manage the risks that matters more.” I like this comment, so the question is “Is selling options worth the Risk?”

    How do you access the Risk of the option position? It’s a complicated process of mathematical calculation based on volatility, beta, delta, gamma, vega, rho, etc, with many trading strategies being employed to find the edge. Trading is all about finding that edge, if not, simply selling options based on gut feel is just a gamble, of course time is your only edge.

    I know of many fellow traders who sell options, they follow the market very closely, sometimes to hedge their positions, it’s not simple, plenty of stress when the market turn volatile due to unforeseen events that might happen.

    I agree with the comments of my good friend, Coconut, he is a real veteran in term of knowing the risk involved.

    A fellow trader who is an option market maker on the trading floor no longer trade options due to the risk involved. He find the risk and stress not worth his effort because the market is so efficient that he can hardly find the edge.

    I still do occasionally sell options though, just a small gamble and don’t mind holding to that position once it’s been exercised.

    • Alvin Chow
      Posted at 13:15h, 02 February Reply

      It is a pleasure to have experienced traders like coconut and Patrick to chip in.

      I didn’t sell on gut feel. There are rules of entry. The only issue is my risk management rules were not robust enough. I totally agree with you it isn’t easy to fully calculate the risks in options. It is definitely stressful when the market is moved against my position.

      Appreciate your concern about options trading, or trading in general. I will definitely keep your perspective in mind as I weigh my options whether to trade or not.

  • coconut
    Posted at 16:46h, 02 February Reply

    yes yes yes!

    it is definately not enough to have a robust risk management rules, robotic discipline and iron heart to trade profitably with consistency.

    you need to find the edge, an edge that is just above 50% net less cost. 51% is good enough if you can apply all your resources, your capital and your mind into it. the rest are just number’s game.

    • Alvin
      Posted at 19:00h, 02 February Reply

      yes Patrick and coconut, the strategy has an edge bcos I learned it from Dave, who has been trading it for a living in the past 10 years or so.

      the big loss showed that I am not able to manage my own greed and that was why all my reflection was about size and stop loss.

      anyway I won’t be trading for the time being. I have closed all my positions.

      • coconut
        Posted at 08:10h, 03 February Reply

        good for you to close all your position, take a rest for about 3-6 months at least. let me assure you that any experience traders will tell you they had all gone through what you have gone through, some even worst, and many more times. think this way and you would not feel that bad. thats trading.

        you have a tutor who willing to teach you his winning strategy, stick to it, you wouldn’t find another one that easy!

        • coconut
          Posted at 08:33h, 03 February Reply

          after trading for many years, i’ll tell from my heart that if someone comes to say he has a winning strategy or fomular, watch out with doubts!

          to me all methods there is in trading, can in one point in time will able to make money. any strategy. in this electonic trading world where no one really have an edge, the experience trader will have to learn as much the strategy there is and apply them according to market condition. more often multiple strategy at the same time!

          having a single method and a single mind is not going to last very long.

  • Alvin
    Posted at 08:41h, 03 February Reply

    Trading has enable me to see myself better. I believe I will be a better person if I become a better trader, and vice versa.

  • BL
    Posted at 21:48h, 09 February Reply

    I used to work as a futures dealer in the past. Futures trading customers have high casualty rate. Along the way I single out 2 traders whom I thought can prove me wrong that futures trading cannot win. Eventually they suffer huge losses as well. Statistics show that almost nobody win in futures trading. If you think you have the substance to beat the statistic, then you trade futures. Or else equity investment is certainly a easier financial instruments to make money.

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