Advanced Options Training: Risky Business Class 2: Risk Practicum

Class 2: - Risk Practicum

Review
“We all have dreams. But in order to make dreams come into reality, it takes an awful lot
of determination, dedication, self-discipline, and effort.” -- Jesse Owens (Athlete)

Risk Unit (R)

• A trader’s R should be no more
than 2% of their cash account value:
➡ With a $2,500 account you
would be trading a $50 R
➡ With a $10,000 account you
would be trading a $200 R
• Therefore, no more than 2% of
your account should ever be at risk
on a trade
• Assuming a $2,500 account, you now know your R value is $50

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Advanced Options Training: Risky Business Class 2: Risk Practicum

Trading R’s
• To determine how many shares (or contracts) to buy, divide R by the size of
your stop.
➡ $50R ÷ $0.25 Stop = 200 Shares
➡ $50R ÷ $2.00 Stop = 25 Shares
➡ $100R ÷ $0.25 Stop = 400 Shares
➡ $100R ÷ $2.00 Stop = 50 Shares

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Advanced Options Training: Risky Business Class 2: Risk Practicum

Using Options With R’s

R Trading With Options
• Unlike trading stock, the value of an option factors multiple elements to
determine price
• A few of those elements are
➡ Delta and Intrinsic Value
➡ Theta (Time Decay)
➡ Vega (Volatility)
➡ Less impactful: Current Interest rate, Current Dividend Rate

Some Known Issues

• Your Delta will change as the underlying stock begins to approach your Target
or Stop
• Time will immediately begin decreasing the value of your option (theta)
• Volatility can sometimes be unexpected (IV)

Before we go any further... let’s make an agreement. You

could chose to look at everything you don’t know about
future option pricing and decide to throw risk management
out the door. Or, we can focus on what we DO
know and make some very educated
assumptions.

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Advanced Options Training: Risky Business Class 2: Risk Practicum

What DO We Know?
• We know that as trade moves in our favor... the Delta will be improving
(meaning we’re making more money)
• We know that as the trade moves toward our stop our Delta will be
decreasing (meaning we’re losing less money)
• We know that time decay is nominal when we are following our option rules
(from FOSO)
• We know that if we are entering low volatility trades... an increase in volatility
will only improve the value of our option.

How to Calculate R For Options

• As option traders we are expecting the underlying security to move and
improve the value of our options.
• The primary Greek to determine this type of price movement is Delta.
• Remember, a Delta of .50 means your option will move $0.50 for every $1 of
stock movement.

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Advanced Options Training: Risky Business Class 2: Risk Practicum

How to Calculate R For Options (continued)

• By calculating your stop based on Delta, you insure you’re working with the
maximum loss potential (assuming follow the rules for trading options in
FOSO)
• As a bonus... when the stock price moves it will only improve the delta in
your favor!
• A “mostly” 3R target with stock will be achieved with options!

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Advanced Options Training: Risky Business Class 2: Risk Practicum

Original Option Calculation

If our STOP was Achieved... here is the new option value

If our TARGET was Achieved... here is the new option value

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Advanced Options Training: Risky Business Class 2: Risk Practicum

Trader Progression & Compounding R

Trader Progression Chart
(Swing Trading)
R Max Loss Max Loss R Target R Target Monthly
Account Size Per Profit
Level Per Trade Per Week Per Mo.
Week Target
$2,500 - $3,500 $50 1R 2R 3R 5R $250

$3,500 - $5,000 $70 1R 2R 4R 6R $420

$5,000 - $7,500 $100 1R 2R 5R 8R $800

$7,500 - $10,000 $150 1R 2R 6R 10R $1500

$10,000 - $15,000 $200 1R 4R 7R 12R $2400

$15,000 - $20,000 $300 1R 4R 8R 14R $4200

1% to
$20,000 and Up 2%
1R 8R 12R 20R Sustainable :)

How fast can I…?!? Month Capital Growth Result

• One of the most common questions of
1 $10,000 20% $2,000

beginning FOSO students is: “how quickly 2 $12,000 20% $2,400

can I expect to grow my account?” 3 $14,400 20% $2,880

4 $17,280 20% $3,456
• Then they discover options trading and 5 $20,736 20% $4,147
see returns of 20% and higher!
6 $24,883 20% $4,977
• The deadly 1.20 calculation... 7 $29,860 20% $5,972
8 $35,832 20% $7,166
9 $42,998 20% $8,600
Is this possible? ________ 10 $51,598 20% $10,320

Is this the right goal? _______ 11 $61,917 20% $12,383

12 $74,301 20% $14,860
What is a better goal? ________________ 12+ A Gazillion Dollars!

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Advanced Options Training: Risky Business Class 2: Risk Practicum

A System of Trader Progression

• Rule 1: Everybody starts at a $50 R
• Rule 2: An R Level is eligible for increase after 3 consecutive weeks of
achieving R targets
• Rule 3:Your account size should meet minimum requirements of your R Level
• Rule 4: Two consecutive Max Week Losses require an R Level reduction

Joe’s Progression
Actual New
R Max Loss Max Loss R Target Week
Week Account
Level Per Trade Per Week Per Week Profit
Result Size

Week 1 $50 1R 2R 3R 4R $200 $5,200

Week 2 $50 1R 2R 3R 0R $0 $5,200

Week 3 $50 1R 2R 3R 10R $500 $5,700

Week 4 $50 1R 2R 3R 3R $150 $5,850

Week 5 $50 1R 2R 3R 2R $100 $5,950

Weeks 6-8 $70 1R 2R 3R 10R $700 $6,650

Homework
• Find a minimum of 2 possible trade setups (they don’t have to be perfect),
and calculate the number of shares and also the number of options you
would need to buy.
• Repeat the first assignment 3 additional times using different R units.
Consider working through $50R, $70R and $100R.

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