11. Manage Risk by "Scaling-into" Positions

As mentioned in my book, Trading Options Visually, I like the acronym "F.A.D.S." (Find, Adjust, Diversify, Scale-in) because it reinforces four essential elements of delta neutral volatility trading.

Finding desirable option positions is about as far as most traders go, but adjusting positions in accordance with a pre-determined trading plan is necessary because the path a market takes is unpredictable. In addition, knowing in advance the modifications you'll make if the market moves a certain amount promotes a sense of security, avoids procrastination, and eliminates second-guessing trading decisions you've made.

Diversification among markets and using different strategies is an obvious risk management technique.

The last element ("scaling-into" positions) is often overlooked even though it's another powerful risk management tool. Successful stock market investors recognize its value when they "dollar cost average" their purchases. The basic principle is than investing a fixed dollar amount at one time is more risky than investing one-third of the amount on the same day for three consecutive months.

"Scaling-into" positions ensures that your average entry price on purchases won't be at the extreme high and your average sales price won't be at the extreme low.

Option traders have a shorter trade horizon than stock traders, so after establishing an initial position, they can plan to scale into a second position a week later and then a third position a week following the second.

Of course, each successive position should be delta neutral starting out. Then monitoring the overall position's Greeks is important so it's clear when it's time to adjust.

"Knowledge is power and all traders can benefit by continually bolstering their knowledge base. I hope to contribute in that regard."  Paul Forchione