"When the going gets tough, the tough get going."
The above could almost be the motto for options traders around the world. What could be more fitting for a group that gets more engaged in financial markets when uncertainty increases?
In the traditional financial community, a pop in volatility usually triggers a retreat mentality. Not so for volatility traders, who often find their best opportunities when markets are correcting.
The nature of such a role means that volatility traders have an intimate relationship with risk. Just as ballerinas glide across the stage, options traders are constantly gliding across that thin plateau that separates profit from loss.
As market conditions shift, traders are often required to adjust the risk vs. reward balance in their portfolios. If you’ve been looking to improve upon your portfolio management skills, particularly as it relates to managing risk, a new episode of Best Practices should be right up your alley.
The purpose of the show is to help illustrate how traders can adjust their tactics to dial up potential rewards, or dial back potential risks, depending on their outlook and current market conditions.
What makes this episode of Best Practices so powerful is that the show features a series of illustrated graphics containing examples which perfectly drive home how risk and reward are so closely intertwined. Generally speaking, as potential rewards increase, so do potential risks - and vice versa.
On the show, the hosts use the terms “potential return on capital" (i.e. reward) and “probability of profit” (i..e risk) to drive home their points. We note this only to highlight a subtle difference in semantics - the relationship between potential return on capital and probability of profit is actually an inverse one (as potential return goes higher, the probability of profit goes lower).
This relationship is depicted below:
Because this episode relies on the power of the graphics, we recommend you review the complete episode (and associated research slides) when your schedule allows.
If you have any outstanding questions about managing risk in your portfolio, we hope you’ll reach out by leaving a message in the space below or by sending us an email at email@example.com.
We look forward to hearing from you!
Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.
Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.