Risk Management & Position Sizing for Options Traders

The Framework That Protects Capital and Builds Longevity

Every new trader obsesses over the right strategy. Covered calls, iron condors, straddles, everyone wants to know which trade has the best payoff. But the truth is sobering: strategy alone will not save you.

The difference between traders who last and those who flame out comes down to one thing, risk management. More specifically: how you size positions, how you control drawdowns, and how you build a portfolio that can survive uncertainty.

Why Position Sizing Matters More Than Strategy

Imagine two traders running the exact same strategy. One risks 50% of his capital on each trade. The other risks 3%.

They could have identical win rates. Identical entries. Identical exits. The first will likely blow up in weeks. The second could compound for years.

Position sizing is the hidden edge. It transforms good strategies into sustainable businesses and prevents bad streaks from ending your career.

The Max Loss Rule: Protecting the Floor

The first layer of protection is simple: define the maximum you’re willing to lose on any single trade.

• For most professional option sellers, the answer is 1% to 3% of portfolio capital per trade.

• Higher than that, and one unlucky streak can wipe out months of gains.

For example:

• On a $100,000 portfolio, risking 2% means no trade should lose more than $2,000.

• If you’re selling a credit spread with $5,000 in buying power at risk, you’d only allocate two contracts, not five or ten.

This isn’t about squeezing every penny from a trade. It’s about surviving long enough for probability to work in your favor.

Managing Drawdowns: The Law of Large Numbers

Even with high-probability trades, losing streaks happen. You might win 70% of the time over the long haul, but in the short term you can lose five trades in a row.

If you risk too much per trade, that streak becomes catastrophic. If you risk a modest percentage, it’s a speed bump.

My rule of thumb: design your portfolio so a losing streak of 7 to 10 trades won’t take you out of the game. That means keeping position sizes small enough that drawdowns are uncomfortable, not fatal.

Think of it this way: the best traders don’t avoid pain. They make sure the pain is survivable.

Portfolio-Level Risk Control: The 3 Layers

I treat my options portfolio like a business with three risk-control layers:

1. Per Trade Risk

   • No trade exceeds my 1-3% max loss rule.

   • Defined-risk trades (credit spreads, condors) make it easier to quantify.

2. Strategy Allocation

   • I diversify across strategies: roughly 70-90% in core income (wheel, covered calls, PMCCs), 10-30% in spreads/condors, and a smaller slice in event trades (earnings, straddles).

   • This way, no single approach dictates results.

3. Portfolio Drawdown Guardrail

   • I monitor total equity. If I draw down more than ~10-12%, I scale back position sizes until I stabilize.

   • This keeps me from compounding errors when confidence is shaken.

Together, these three layers form the backbone of true portfolio risk management.

The Psychology Trap: Why Traders Ignore Sizing

Most blowups don’t come from ignorance, they come from overconfidence. After a winning streak, traders double down. They assume they’ve “earned” the right to size bigger.

That’s the paradox: the better things are going, the more disciplined you must be. Professional traders know probability doesn’t bend to ego.

I learned this lesson early in my career, back when options were still quoted in fractions. After six months of steady income, I doubled my size on a string of iron condors. The market exploded, volatility surged, and I lost nearly half of my annual gains in a week. The strategy wasn’t wrong. My sizing was.

A Framework for Individual Traders

Here’s a simple, repeatable framework you can apply immediately:

• Risk per Trade: 1-3% of account value.

• Contracts per Trade: (Max Loss $ ÷ Risk Per Contract). Always round down.

• Strategy Mix: 40-50% stable income strategies, 30-40% spreads/defined risk, 10-20% tactical/speculative.

• Portfolio Guardrail: Scale back if equity falls 10-12% from highs.

Follow this, and you’ll avoid the fatal mistake most option traders make: mistaking leverage for safety.

Final Word: Staying Power Beats Flash

Options give us leverage. They give us income. They give us flexibility. But they also punish indiscipline without mercy.

The real edge isn’t which strategy you use. It’s how you size your risk, control drawdowns, and manage the portfolio as a whole.

Anyone can win a trade. Only disciplined traders win a career.

Probabilities over predictions,

Andy Crowder

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