I would like to explain in very simple terms and easy to understand by pro and novice et al.
Step I:
1) Decide on Portfolio Allocation: Portfolio allocation starts with defining Financial Objectives : How much money you would need and when? Your assets, liabilities, income and expenditure. This is a different subject altogether but still ultimately one (even a trader) has to start here.
(a) Variable (positive / negative): Equity, Real estate, Gold, F&O (Directional positions)
(b) Variable (positive but unsteady returns) : F&O (multilegged strategies primarily using Options)
(c) Fixed (positive) : FDs, NSCs, PPF etc
2) Decide on time frame to adjust Protfolio Allocation : Could be quarterly, half yearly or yearly. Depending on your portfolio performance, income from other sources/job/inheritance etc
Step II: Here I am zeroing on the aggressive part of portfolio allocation - Trading in Options:
1) Risk = Uncertainty of DESIRED outcome
2) Desired Outcome = (a) + (b)
(a) Primary Desired Outcome = For position taken at Time T0, price CHANGES in favour of position taken at Time T1
(b) Secondary Desired Outcome = MAGNITUDE of price change from P0 (at Time T0) to P1 (at Time T1)
Hence at Time T0 and Price P0, we need to define both, T1 and P1.
For a one market, one instrument, one trading plan trader (like me) T1 is sacrosant (FIXED), P1 is the only variable.
P1 is defined before trade initiation. P1 is defined both for positive outcome and for negative outcome.
Eg If I am buying Nifty Options @ time Time T0 at price P0 (Rs. 100), and defined is P1 is Rs. 95 (worst drawdown) or Rs. 107 (best outcome), my Risk is Rs. 5. (Rs. 250 for one lot).
If my trading capital (which is PART of my Portfolio) is say 10 L and I decide to RISK 2% per trade (this % is decided at the end of each week for the next week depending on the performance in the week gone by. The range of Risk / trade is between 1% to 4%), then I would buy 80 lots of Nifty Options.
At time T1, the probable outcome of Option prices could be:
93 : Exit fully (2.8% loss of trading capital : 80 x 50 x (-7) = -28000)
95 : Exit fully (2% loss of trading capital : 80 x 50 x (-5) = -20000)
97 : Exit fully (1.2% loss of trading capital : 80 x 50 x (-3) = -12000)
100: Exit fully (0% loss of trading capital : 80 x 50 x 0 = 0)
103: Exit 75% (0.9% profit to trading capital : 60 x 50 x (+3) = +9000)
106: Exit 50% (1.2% profit to trading capital : 40 x 50 x (+6) = + 12000)
109: Exit 25% (0.9% profit to trading capital : 20 x 50 X (+9) = +9000)
You would notice that if the price at Time T1 is less than 100 I exit fully and on some occasions the loss could be higher then anticipated 2% in this case if I exit at 93. But this margin of error in my risk management is acceptable since I exit at Time T1.
Secondly you would notice that at price levels > 100 (i.e. 103, 106, 109) I have partially exited. But these exit % are NOT RANDOM.
If the price is > 100 at Time T1, then this T1 becomes new T0 and the current price say 103 become new P0. From here I would again calculate new P1 (both worst drawdown and best outcome scenario) and accordingly adjust the quantity.
Step III: Later today/tomorrow...:
Regards,
Step I:
1) Decide on Portfolio Allocation: Portfolio allocation starts with defining Financial Objectives : How much money you would need and when? Your assets, liabilities, income and expenditure. This is a different subject altogether but still ultimately one (even a trader) has to start here.
(a) Variable (positive / negative): Equity, Real estate, Gold, F&O (Directional positions)
(b) Variable (positive but unsteady returns) : F&O (multilegged strategies primarily using Options)
(c) Fixed (positive) : FDs, NSCs, PPF etc
2) Decide on time frame to adjust Protfolio Allocation : Could be quarterly, half yearly or yearly. Depending on your portfolio performance, income from other sources/job/inheritance etc
Step II: Here I am zeroing on the aggressive part of portfolio allocation - Trading in Options:
1) Risk = Uncertainty of DESIRED outcome
2) Desired Outcome = (a) + (b)
(a) Primary Desired Outcome = For position taken at Time T0, price CHANGES in favour of position taken at Time T1
(b) Secondary Desired Outcome = MAGNITUDE of price change from P0 (at Time T0) to P1 (at Time T1)
Hence at Time T0 and Price P0, we need to define both, T1 and P1.
For a one market, one instrument, one trading plan trader (like me) T1 is sacrosant (FIXED), P1 is the only variable.
P1 is defined before trade initiation. P1 is defined both for positive outcome and for negative outcome.
Eg If I am buying Nifty Options @ time Time T0 at price P0 (Rs. 100), and defined is P1 is Rs. 95 (worst drawdown) or Rs. 107 (best outcome), my Risk is Rs. 5. (Rs. 250 for one lot).
If my trading capital (which is PART of my Portfolio) is say 10 L and I decide to RISK 2% per trade (this % is decided at the end of each week for the next week depending on the performance in the week gone by. The range of Risk / trade is between 1% to 4%), then I would buy 80 lots of Nifty Options.
At time T1, the probable outcome of Option prices could be:
93 : Exit fully (2.8% loss of trading capital : 80 x 50 x (-7) = -28000)
95 : Exit fully (2% loss of trading capital : 80 x 50 x (-5) = -20000)
97 : Exit fully (1.2% loss of trading capital : 80 x 50 x (-3) = -12000)
100: Exit fully (0% loss of trading capital : 80 x 50 x 0 = 0)
103: Exit 75% (0.9% profit to trading capital : 60 x 50 x (+3) = +9000)
106: Exit 50% (1.2% profit to trading capital : 40 x 50 x (+6) = + 12000)
109: Exit 25% (0.9% profit to trading capital : 20 x 50 X (+9) = +9000)
You would notice that if the price at Time T1 is less than 100 I exit fully and on some occasions the loss could be higher then anticipated 2% in this case if I exit at 93. But this margin of error in my risk management is acceptable since I exit at Time T1.
Secondly you would notice that at price levels > 100 (i.e. 103, 106, 109) I have partially exited. But these exit % are NOT RANDOM.
If the price is > 100 at Time T1, then this T1 becomes new T0 and the current price say 103 become new P0. From here I would again calculate new P1 (both worst drawdown and best outcome scenario) and accordingly adjust the quantity.
Step III: Later today/tomorrow...:
Regards,