How Does Theta Involve Risk Management Anyway?


Risk Management is probably one of the most important parts of trading. Tom Sosnoff, TastyTrade,, and all say, “Trade Small, Trade Often”. Partly, this marketing (who makes more commissions when you trade often?), but it is also a very important component of risk management.

Many new traders, regardless of style, try and hit a home run, often times putting more money towards one trade than another, “Knowing” it is going to pay off. Often, it doesn’t, but occasionally, it may. That doesn’t matter. If you trade small, trade often, and put the best trade on you can at the time you hit “Confirm and Send”, you’ll be ahead of most traders.

Positive theta is important because it offsets risk. If you have a positive theta of say $35, on a $20,000 account, if there was zero delta risk for the entire year, you would make ($35 X 365 =) $12,775.00 on theta profits alone. Although you most certainly cannot take all other risk (delta, gamma, etc) off the table entirely, it does show the importance of keeping theta positive, right? After all, if this scenario were to play out (theta maintains at $35 per day; no delta risk, etc), you would make a 64% return on your theta profit alone.

I do enjoy the idea of Delta neutral too, but I’ve found that forcing it can be costly too. I would no longer put on the short call side of an iron condor if it simply did not pay. Often, people put on “Iron Condors”, not realizing one side, or the other is not giving them any ROC. Although putting on an Iron Condor is a great trade, I would also say, each short vertical “side” (call side and put side) need to stand on their own as an equally great trade.

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