Risk Management in Options Trading Is Crucial to Survival

09/24/2014 8:00 am EST

Focus: OPTIONS

Bob Lang

Founder and Chief Analyst, Explosive Options

Bob Lang of ExplosiveOptions.net shares the remarkable true story of poker pro, Jack ‘Treetop’ Strauss, and how options traders shouldn’t rely on luck or an ‘all-in’ philosophy but rather on concrete rules of risk management and tolerance.

Got a chip and a chair? Then you’re still in the game!

The story of Jack ‘Treetop’ Strauss is truly memorable. A towering figure, Strauss was an accomplished poker pro. In 1982, he was playing in the World Series of Poker. It was the third “final table” of his career (he finished second to legend Johnny Moss in 1971). During the second day of the tournament, he was heads up (one-on-one) on a huge pot. After the last card was dealt, he pushed all of his chips into the pot on a bluff. His opponent called and it appeared Strauss was finished. As he stood up, put on his coat and got to ready to leave, he noticed a chip underneath a napkin. Since he did not declare “all in” on his last hand, officials allowed him to stay and play the one chip. Jack was back in the game.

He sat back down, went all in and won the next hand, and the next, about five in a row. Two days later, he had amassed a huge stack of chips, and he ended up beating Dewey Tomko in a heads up battle to win the title. His improbable victory gave rise to the phrase about a chip and a chair.

I bring you this story to illustrate the importance of never putting yourself in a position to be out of the game. Now, clearly Strauss had luck on his side but his luck turned into amazing results and he is forever enshrined on the wall of winners in Vegas, regardless of how he got there.

When we are trading options, we often forget the rules we established before the game starts.  Risk management in options trading is my number one rule in trading. We cannot forget that putting our money at risk makes us vulnerable to market moves and emotional swings. We must establish rules of risk tolerance that allow us to stay in the game. Never do we go “all in” on a play—options, futures, stock—or anything else.

When the adrenaline is flowing and we’re in the heat of the battle, it is easy to conveniently forget our rules. It happens, I totally get it. It even happens to professionals. But if you always remember to keep some dry powder (cash) available, you will avoid the precarious position of “hope and pray.”

All option and stock traders should establish rules to manage their accounts accordingly. Discipline and control trump all else in this game of survival, and isn’t that what investing/trading is all about? There is an element of chance in trading (because the future is unknown), just as there is in poker. Unlike poker, we do not have to make extreme bets to be successful. Strauss got really lucky when he found that lone chip, but that is highly unlikely to happen to you, or me.  Be true to your rules, practice risk management in options trading, and you’ll live to fight another day.

By Bob Lang of ExplosiveOptions.net

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