Why Position Sizing Matters

Position sizing determines how much you risk per trade. It is the most important factor in long-term survival.

Method 1: Fixed Fractional

Risk a fixed percentage of capital per trade.

  • Conservative: 1% per trade
  • Moderate: 2% per trade
  • Aggressive: 5% per trade

Example: Rs 10 lakh capital, 2% risk = Rs 20,000 max loss per trade.

Method 2: Kelly Criterion

Optimal position size based on edge and odds.

# Kelly Formula
kelly = (win_rate * avg_win - (1 - win_rate) * avg_loss) / avg_win

# Example: 60% win rate, avg win 2%, avg loss 1%
kelly = (0.6 * 0.02 - 0.4 * 0.01) / 0.02
kelly = (0.012 - 0.004) / 0.02
kelly = 0.4 (40% of capital)

Use half-Kelly for safety: 20% of capital.

Method 3: Volatility-Based

Adjust position size based on volatility.

  • High volatility: Smaller positions
  • Low volatility: Larger positions

Options Position Sizing

  • Buying options: Max 5% of capital per trade
  • Selling options: Max 2% of capital at risk
  • Portfolio: Max 20% in options

SEBI Disclaimer

Position sizing does not guarantee profits. This article is for educational purposes only.

Half-Kelly: Why Full Kelly Burns

The Kelly criterion f = (b*p - q)/b assumes you know p precisely and that the payoff structure is repeatable. Options violate both assumptions, so professionals routinely use a fraction of Kelly. The reasoning is concrete:

  • Atomic options are one-off, fat-tailed events; estimating a 60% win rate to one decimal place over 30 trades a year is fantasy.
  • Kelly optimises long-run geometric growth but lets single-session drawdowns swing wildly, which most Indian traders cannot fund psychologically or fiscally.
  • Quarter-Kelly to half-Kelly keeps most of the growth while cutting expected drawdown roughly in half.

If full Kelly says a trade deserves 8% of capital, half-Kelly says 4%, and the difference in end-of-year returns is usually single digits while the difference in staying solvent is enormous.

Volatility-Scaled Fractional Sizing

Fixed fractional sizing (risk a fixed percent of account per trade) still leaves you over-exposed when volatility spikes, because the same cash risk now sits on a wider payoff. The upgrade is simple volatility scaling:

  1. Pick a base risk percent, say 1.5% of account per options trade.
  2. Scale up the position when IV rank falls below 25 and scale down when IV rank exceeds 75.
  3. Cap the multiplier between 0.5x and 1.5x so the scaling cannot create leverage monsters.

This still qualifies as fixed fractional, but the fraction moves with the true risk unit, which is volatility, not premium.

The Drawdown Table Every Trader Should Memorise

Losses are compounding enemies, and options traders forget the recovery math:

  • You lose 10%: you need +11.1% to recover.
  • You lose 25%: you need +33.3% to recover.
  • You lose 40%: you need +66.7% to recover.
  • You lose 50%: you need +100% to recover, and that is for the rest.

Sizing is the only variable you control at the moment of a loss; sizing to survive the 25% drawdown is what makes the 100% recovery possible later.

Options-Specific Capital Math

Options sizing adds a layer futures do not have: margin, premium and replication. Three rules capture it:

  • Risk the defined loss, not the premium: for a credit spread, size off the width minus credit, because that is what you can actually lose.
  • Reserve for margin calls: keep 1.3x the margin requirement liquid instead of deploying every rupee.
  • Count correlated trades together: five Nifty spreads pointing the same direction are one trade for sizing purposes, however pretty they look separately.

Nifty Example in Rupees

Suppose an account of ₹5 lakh and a rule of 1.5% risk per trade, so ₹7,500 of defined loss per position:

  • A put credit spread risks ₹3,000 max loss if untouched; you can size two spreads or one 2-lot spread of ₹6,000.
  • A naked-ish short straddle doesn't have a clean defined loss, so size it on options margin instead: around 20% of margin held as a volatility buffer.
  • Daily loss cap of 2% of account, quarterly red-line of 8%, stops a single strategy from compounding its own mistakes.

The volume of trades you take matters less than the volume of risk you leave unrisked each week; discipline is a numbers game, not a heroics game.