How to Manage Risk in Option Trading Like a Pro

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Market Volatility is Back—Here’s Why It Matters

Last week, volatility in the stock market picked up significantly. We saw major events such as:

The Dow dropping over 800 points
Negative news on the coronavirus
A Federal Reserve meeting
The VIX (Volatility Index) spiking again

This kind of movement means two things:

There will be big price swings in stocks and options.
Many traders will lose a lot of money if they don’t manage risk properly.

If you want to protect your account and avoid massive losses, it’s crucial to have a solid risk management strategy in place.

Why Risk Management is Key in Options Trading

When you think of options trading, you probably imagine massive profits—those viral posts of traders making $50,000 in a day on WallStreetBets. While those gains are exciting, they are not realistic for most traders.

The truth is, without risk management, you can blow up your account quickly. So, in today’s video, I’ll walk you through my risk management strategy for trading options, and hopefully, you can apply it to your own trading style.

Understanding Strike Prices and Position Sizing

To explain my risk management strategy clearly, let’s go into the charts and look at a real-world example.

We’re analyzing Boeing’s (BA) one-hour chart, where we see:

Boeing had a strong run-up but recently fell.
It’s retracing into previous resistance levels.
Support at $170 and resistance around $190 with a triple top pattern.

Let’s assume we believe Boeing will drop back to $170 in the next 2–3 weeks. To profit from this move, we would buy a put option.

Now, let’s check Boeing’s options chain to find a strike price that fits within our risk management strategy.

Choosing the Right Contract to Control Risk

Looking at the Boeing options chain, we need to make smart decisions about:

Expiration Date – I never buy options that expire in less than two weeks for short-term trades. My rule of thumb is:
- Short-term trades → At least 2 weeks of time.
- Long-term trades → At least 1-2 months of time.

In this case, I would choose July 2nd expiration (19 days away).

Strike Price Selection – Our target price is $170, and that put option costs about $1,000.

Managing Portfolio Risk the Right Way

Here’s where risk management comes in:

If you have a $2,000 account, buying this contract would risk 50% of your portfolio—way too much!
Some traders say, “I’ll just cut losses at $200”, but options can lose 20% in minutes.
If the stock moves slightly against you, you’re already down $200 in seconds, forcing you into an emotional decision.

This is why trading contracts too expensive for your account leads to unnecessary stress and bad decisions.

A Smarter Approach to Risk Management

Instead of risking 50% of our portfolio, we adjust our strategy:

We decide on a max risk of 10% of our portfolio ($200).
We find a cheaper contract, like a $130 strike put, for about $200–$270.
Even if it expires worthless, we only lose 10% of our portfolio, which is manageable.

The Benefits of This Strategy:

✅ Lower risk per trade – You only risk an amount you’re comfortable losing.
✅ Less emotional stress – If Boeing moves against you slightly, you won’t panic.
✅ More time to hold the trade – Allows your analysis to play out.
✅ Higher percentage gains – Even with a smaller dollar amount, you can make huge % returns.

Final Thoughts on Risk Management in Options Trading

With this strategy, you won’t make crazy WallStreetBets-style gains overnight, but you will:

Protect your capital.
Avoid blowing up your account.
Take higher-probability trades that allow you to stay in the game longer.

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Options trading offers immense potential for profit, but it also comes with significant risks. Successful traders understand that managing risk is just as important as identifying profitable opportunities. In this guide, we will explore How to Manage Risk in Option Trading Like a Pro, covering essential strategies and techniques to help you protect your capital while maximizing returns.

1. Understand the Risks of Options Trading

Before diving into strategies, it’s crucial to understand How to Manage Risk in Option Trading Like a Pro by recognizing the different types of risks involved. These include:

Time Decay (Theta Risk): Options lose value over time, affecting long option positions.
Liquidity Risk: Some options may have low trading volume, making it difficult to enter or exit positions efficiently.
Implied Volatility Risk: Changes in volatility can impact option premiums, affecting profitability.

Being aware of these risks allows traders to take proactive steps to mitigate potential losses.

2. Position Sizing and Risk Allocation

One of the key aspects of How to Manage Risk in Option Trading Like a Pro is proper position sizing.

Risking only 1-3% of total capital per trade to prevent large losses.
Diversifying trades across different assets or strategies to minimize exposure to a single market event.
Using stop-loss orders or mental stops to exit losing trades before losses escalate.

Proper risk allocation ensures that no single trade can wipe out a significant portion of your portfolio.

3. Use Stop-Loss Orders and Exit Strategies

Another crucial technique in How to Manage Risk in Option Trading Like a Pro is having a well-defined exit strategy. Traders should implement stop-loss orders to limit downside risk. Some effective approaches include:

Percentage-Based Stop Loss: Exiting a trade if the option price declines by a set percentage.
Time-Based Exits: Closing a position before expiration to avoid excessive time decay.
Profit Target Exits: Taking profits at predefined levels to lock in gains before market conditions change.

Having a clear exit plan reduces emotional decision-making and prevents unnecessary losses.

4. Hedging Strategies to Minimize Losses

Hedging is an advanced technique that professional traders use to protect their portfolios. As part of How to Manage Risk in Option Trading Like a Pro, traders can employ various hedging strategies such as:

Protective Puts: Buying put options to hedge long stock positions against market downturns.
Covered Calls: Selling call options against owned stock to generate income and reduce downside risk.
Spreads (Vertical, Calendar, or Iron Condors): Combining multiple option positions to limit risk while maintaining profit potential.

Using hedging techniques can help traders minimize losses while still participating in market movements.

5. Managing Implied Volatility and Time Decay

Understanding How to Manage Risk in Option Trading Like a Pro requires knowledge of implied volatility and time decay. These factors significantly impact option prices:

Low Implied Volatility: Buying options when volatility is low can result in higher profits if volatility rises.
High Implied Volatility: Selling options during high volatility can generate income as volatility contracts.
Theta Management: Selling options with short expiration periods benefits from time decay, while buying options requires careful timing to avoid value erosion.

By monitoring volatility and time decay, traders can improve their trade timing and risk management.

6. Keep a Trading Journal and Review Performance

The final step in How to Manage Risk in Option Trading Like a Pro is maintaining a trading journal. Keeping records of all trades, including entry/exit points, strategy used, and market conditions, helps traders:

Identify patterns in their trading behavior.
Learn from past mistakes and refine strategies.
Track risk-reward ratios to ensure a sustainable trading approach.

Regularly reviewing performance allows traders to adjust their risk management techniques and improve long-term profitability.