Is twice the cash twice the fun? Not if you take utility into account. Get some perspective on how much benefit you’ll get from the next dollar.
Visions of sugarplums ain’t just for fairytales. Maybe you’ve traded your way to a much bigger account size. Or Uncle Milt left you a huge chunk of change. Whatever the source, you’ve come into serious money. Exciting? Sure. But now what?
Some would consider doubling their trade size after doubling their account. After all, if you’re willing to risk $500 a trade with $50,000, why not $1,000 a trade with $100,000? No wrong answer here. But again, perspective is crucial. Above all, consider your capital’s “utility”…huh?
Simply put, utility measures how much benefit you’ll get from the next dollar. One dollar to someone whose net worth is $100 is a big deal. One dollar to a millionaire, not so much. In trading, potential reward is always tied to risk. If you want more reward, you typically need to take on more risk. The utility you have with that extra trading profit helps determine whether you would in fact take the extra risk.
Twenty-somethings have plenty of time before retirement, so their accounts have time to potentially recover from losses. In this scenario, the utility a younger investor realizes for his potential trading profit might be high enough to encourage more risk. Why? The dollar today will likely buy less tomorrow. To offset the cost of a more expensive future, a young person may take more risk with a profit “windfall.” For someone closer to or already in retirement, taking extra risk could cause a loss from which it may be harder to recover. This could make that potential and incremental profit less attractive. Either way, younger or older, there are potentially smarter ways to adjust incremental risk to fit your lifestyle and trading goals.
One possible solution suggests increasing position risk incrementally as your account grows. For example, instead of increasing risk by 100%, maybe you go, say, 25% instead, from $500 to $625, instead of from $500 to $1,000. This could mean doing more contracts, or simply adjusting spread strikes so they’re wider.
If you were, say, to sell four 100/102 put spreads for $0.75 credit, that would have a max risk of $500, not including commissions ($2 spread - $0.75 credit = $1.25 risk. $125 X 4 = $500). If you widened the strikes and sold three of the 99/102 put spreads for 0.95 credit, that would have a max risk of $615, not including commissions.
If you’re comfortable with a 25% increase in risk, you may consider increasing risk by another 25%, and work your way up over time to doubling your risk. If you’re not comfortable with a 25% increase in risk, it’s easy to back off and try to avoid larger losses. This way, your potential profit will be delivering the appropriate balance of risk and reward that makes the most sense for your personal financial situation, without throwing caution to the wind (never a good idea).
for thinkMoney ®
Financial Communications Society 2016
for Ticker Tape
Content Marketing Awards 2016
Tom Preston is not a representative of TD Ameritrade, Inc. The material, views and opinions expressed in this article are solely those of the author and may not be reflective of those held by TD Ameritrade, Inc.
Market volatility, volume, and system availability may delay account access and trade executions.
Past performance of a security or strategy does not guarantee future results or success.
Options are not suitable for all investors as the special risks inherent to options trading may expose investors to potentially rapid and substantial losses. Options trading subject to TD Ameritrade review and approval. Please read Characteristics and Risks of Standardized Options before investing in options.
Supporting documentation for any claims, comparisons, statistics, or other technical data will be supplied upon request.
The information is not intended to be investment advice or construed as a recommendation or endorsement of any particular investment or investment strategy, and is for illustrative purposes only. Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade. Clients must consider all relevant risk factors, including their own personal financial situations, before trading.
This is not an offer or solicitation in any jurisdiction where we are not authorized to do business or where such offer or solicitation would be contrary to the local laws and regulations of that jurisdiction, including, but not limited to persons residing in Australia, Canada, Hong Kong, Japan, Saudi Arabia, Singapore, UK, and the countries of the European Union.
TD Ameritrade, Inc., member FINRA/SIPC. TD Ameritrade is a trademark jointly owned by TD Ameritrade IP Company, Inc. and The Toronto-Dominion Bank. © 2018 TD Ameritrade.