Many retail traders – including myself – have blown up their accounts because they ignored position sizing. But how much you risk on each trade is one of the most important elements in succeeding in options trading.
I sat down with experienced retail trader Eric O’Rourke to discuss this topic. Eric is the host of the podcast Stock Market Options Trading, has a community with the same name, and also run the options trading service Alpha Crunching.
The interview is full of value bombs for a beginner or intermediate options trader who wants to succeed. Check out the full interview for actionable insights!
Watch the video interview with Eric O’Rourke here
The video was produced with Streamyard – an easy-to-use and amazing tool for live streaming and recording.
Why position sizing matters
Eric emphasized that position sizing is a cornerstone of successful trading, particularly in options, where leverage amplifies both potential gains and risks.
“If you’ve been in the game long enough, you’ll realize position sizing is the most important thing if you want to grow your account or create income over time,” he explained.
For many traders, position sizing only becomes a priority after establishing their strategies. According to Eric, understanding how much to risk per trade is essential for managing drawdowns and staying in the game long enough to see long-term success.
Four components of options trading success
Position sizing is one of four critical elements in evaluating a trading strategy:
- Win and loss rate: The percentage of trades that result in profits versus losses
- Average win size: The average profit from a winning trade
- Average loss size: The average loss from a losing trade
- Position sizing: How much of your portfolio is allocated to each trade
The first three equal the expectancy of a trade – estimated by the following formula:
Expectancy = (win rate * average win) – (loss rate * average loss)
Eric emphasized the importance of understanding the math behind your strategy, including expectancy calculations.
“Your win rate, average size of winners, and losers are the game. Position sizing ties it all together,” he said.
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Practical examples of position sizing
Eric shared a detailed example using a $100,000 account and a strategy focused on weekly SPX put credit spreads with a 73% win rate. The specific strategy is not of interest in this context – the most important is that all examples are based on the same mechanics.
In the video he shows how the returns, but also the drawdowns, change in five scenarios. In all scenarios he backtested for the period from January 1st, 2023 until November 9, 2024:
- 1 contract allocation: Annual return of 1.6% and a max drawdown of 1%
- 1% of the account allocated: Annual return of 4.9% and a max drawdown of 2.8%
- 2% of the account allocated: Annual return of 10.9% and a max drawdown of 6.4%
- 3% of the account allocated: Annual return of 17.4%, but with a max drawdown of 9.8%
- 10% of the account allocated: Annual return of 66.6%, but now with a huge max drawdown of 31.1%.
As we see, the returns grow the more of the account we are willing to risk. However, the drawdowns also increase in size and may ultimately blow up our account if we are not careful.
Eric advised traders to stick to 1% or 2% allocation for most strategies, particularly for those with smaller accounts, to balance growth and risk.
Personality and strategy alignment
“Your position sizing should match your trading style and risk tolerance,” Eric noted. He explained that high-probability trades, such as credit spreads, often come with skewed risk-reward ratios. Conversely, strategies with lower win rates but larger average wins can also be profitable if they align with the trader’s personality.
Eric encouraged traders to test strategies thoroughly, using automated backtesting to gain confidence in their win rates and expectancy. This discipline allows traders to execute consistently, even after a losing trade.
Key takeaways for beginner traders
For beginners, Eric shared these essential tips:
- Start small and focus on mastering one strategy, one ticker, and one duration.
- Learn the basics of options, including the risks of assignment and leverage.
- Use tools like SPX or XSP to practice with manageable position sizes.
- Prioritize backtesting to build confidence and refine your approach.
“Position sizing is probably the biggest factor in growing your account,” Eric concluded. “But you need a solid strategy and discipline to make it work.”
