Option Trading, Risk Management, and The Global Macro Trader
During tumultuous markets, the global macro trader often finds himself in lonely company. Instead of losing a lot or even most of his money the macro trader often finds that he has generated strong returns while most other trading styles have failed. Because of the macro traders penchant for risk it is important for them to practice sound risk management principles.
One of the first and most important risk management tools available to the macro trader is the practice of positions sizing. Position sizing is when you determine an optimal amount to risk on a trade. Obviously several factors can go into your position sizing algorithm. You can look at the probability of the trade working out. You can look at the over all risk versus reward ratio. And you can look at how much of your portfolio you want to risk. Obviously there are hundreds of potential variables that you can input into your position sizing model.
Once you have determined the right position size, or amount to risk on a given trade it is now time to look at how you can structure the trade to maximize your risk to reward and to cut off tail risk. What is tail risk? Tail risk is a term used to describe risks that fall outside of a normal distributed curve. Essentially a tail risk is something like a bomb going off in a major city or the CEO of a company getting arrested for fraud. Anything that can absolutely destroy a position is considered a tail risk.
One of the easiest ways to cut off tail risk is by building your position using options. When you are a net buyer of volatility, which is to say that you are long options whether they be calls or puts, you are only risking the amount that you have put into the trade. For instance if the option position costs you one thousand dollars then you can not lose more then that.
You can use option to cut off your tail risk because options have very symmetrical payoffs. If you are long a call or a put then you can only lose the money that you have put in but your payout can be many multiples of what you put in.
Of course as with anything there is a potential downside to using option to cut off tail risk. The risk is two fold. One is that you may be overpaying for the options. Depending upon the situation that may or may not matter but it is important to be aware of.
Another risk is that you need to ensure that you know your trading timeframe. If you are hoping to hold the position for several years then you will likely want to reconsider options. If on the other hand you are hoping to hold it for a few day up to a year or so then options may very well be your holy grail.
Ensure that when you are trading that you look at al the available ways to express your market view. By doing this you will often use options and in so doing improve your global macro trading results. - 23208
One of the first and most important risk management tools available to the macro trader is the practice of positions sizing. Position sizing is when you determine an optimal amount to risk on a trade. Obviously several factors can go into your position sizing algorithm. You can look at the probability of the trade working out. You can look at the over all risk versus reward ratio. And you can look at how much of your portfolio you want to risk. Obviously there are hundreds of potential variables that you can input into your position sizing model.
Once you have determined the right position size, or amount to risk on a given trade it is now time to look at how you can structure the trade to maximize your risk to reward and to cut off tail risk. What is tail risk? Tail risk is a term used to describe risks that fall outside of a normal distributed curve. Essentially a tail risk is something like a bomb going off in a major city or the CEO of a company getting arrested for fraud. Anything that can absolutely destroy a position is considered a tail risk.
One of the easiest ways to cut off tail risk is by building your position using options. When you are a net buyer of volatility, which is to say that you are long options whether they be calls or puts, you are only risking the amount that you have put into the trade. For instance if the option position costs you one thousand dollars then you can not lose more then that.
You can use option to cut off your tail risk because options have very symmetrical payoffs. If you are long a call or a put then you can only lose the money that you have put in but your payout can be many multiples of what you put in.
Of course as with anything there is a potential downside to using option to cut off tail risk. The risk is two fold. One is that you may be overpaying for the options. Depending upon the situation that may or may not matter but it is important to be aware of.
Another risk is that you need to ensure that you know your trading timeframe. If you are hoping to hold the position for several years then you will likely want to reconsider options. If on the other hand you are hoping to hold it for a few day up to a year or so then options may very well be your holy grail.
Ensure that when you are trading that you look at al the available ways to express your market view. By doing this you will often use options and in so doing improve your global macro trading results. - 23208
About the Author:
If you need actionable trading ideas then check out The Macro Trader It is a weekly global macro trader advisory publication with frequent intra-week updates for time-critical analysis and actionable trading ideas.
posted by X - Men @ 12:42 AM
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