Most people size an options position by what they can afford to put up. That is the wrong number, and for sold positions it is dangerously wrong, because the amount blocked and the amount at risk are not the same thing.
The correct input is the worst case, which for some positions is knowable exactly and for others is not knowable at all.
Start from the maximum loss, and know when there is not one
Every position falls into one of two categories, and the distinction decides everything that follows.
Defined risk. A bought option can lose the premium and nothing more. A vertical spread can lose the net premium paid, or the strike width minus the credit received. In both cases the worst case is a figure you can write down before entering, which is what makes sizing possible.
Undefined risk. An unhedged sold option has no such figure. A short call option's loss has no ceiling at all, and a short put option's loss is bounded only by the underlying going to zero, which is a bound in mathematics rather than a bound in practice. Margin is blocked against these positions, and that blocked amount is collateral rather than a maximum.
So the first question before sizing anything is which category you are in. For defined-risk positions, the arithmetic below works. For undefined-risk positions, there is no honest sizing calculation, because the input the calculation needs does not exist. What you can do is convert the position into a defined-risk one by buying a protective leg, or accept that you are sizing against an assumption about how far the market can move — and assumptions of that kind are wrong precisely on the days that matter.
This is the strongest practical argument for spreads over naked short positions, and it has nothing to do with expected returns. It is that one of them can be sized and the other cannot.
The arithmetic
For a defined-risk position, sizing is three steps.
Step one: decide the risk per position as a share of the account. A common range is one to two percent of trading capital, and the specific figure matters less than having one. On a two lakh account, two percent is four thousand rupees.
Step two: compute the maximum loss per lot. For a bought option it is the premium multiplied by the lot size. For a debit spread it is the net premium multiplied by the lot size. Include charges, which on a small position are not negligible.
Step three: divide. Risk budget divided by maximum loss per lot gives the number of lots. If the answer is less than one, the correct number of lots is zero, not one.
That last sentence is where most of the damage in retail options happens. A lot cannot be divided, so when one lot exceeds your risk budget there is no smaller version of the trade. Taking it anyway means accepting a risk you have already decided is too large, and the fact that it was the only available size does not change that.
Two adjustments worth making. Count total exposure, not individual positions. Four positions each risking two percent is eight percent at risk, and if they are all on the same index they are closer to one position than four. A separate limit on total open risk — five or six percent is a common choice — prevents the account being quietly fully committed. And reduce after losses rather than after gains. If the account is down, the rupee value of one or two percent is smaller, which happens automatically if you recompute from the current balance rather than the starting one.
What to do when one lot is too big
This is the situation most smaller accounts are actually in, and the honest options are limited.
Trade index contracts rather than single-stock ones. Contract values differ substantially, and index options are also cash settled, which removes the delivery obligation that makes an oversized single-stock position worse.
Use spreads to cut the maximum loss per lot. Selling a further strike against your bought option reduces the net premium, and the maximum loss falls with it. The second leg costs something in charges and caps the gain; it also brings the position inside a budget it was previously outside.
Choose a strike with a smaller premium, carefully. A cheaper, further out-of-the-money option does reduce the maximum loss per lot. It also reduces the probability of the position being worth anything, so this shrinks risk by shrinking the trade's chance of working rather than by improving it.
Wait. The genuinely correct answer often, and the one nobody wants. If the smallest available position is too large for the account, the account is too small for that instrument today. Building it while learning on paper costs nothing but patience.
What not to do: fund the position from outside the trading account so it fits. That removes the only mechanism enforcing the limit, and it is how a bad month turns into a bad year.
An account that shows both numbers
Contract value and blocked amount, per position. Free to open
Three mistakes the arithmetic is protecting against
Sizing by margin. The blocked amount is what the exchange requires as collateral against expected movement. It is not the maximum loss, it moves on its own when volatility rises, and on a sold position the loss can exceed it. Treating margin as the risk figure is the most common structural error in this subject.
Sizing by conviction. Taking a larger position because you are more confident sounds reasonable and fails for a specific reason: confidence is highest exactly when a view is most consensual, which is when it is most likely to be priced in already. A fixed percentage removes the input that is least reliable.
Sizing up after a good run. Increasing size after several winners is how a year of careful work is given back in a fortnight. The account has grown, so the rupee value of your fixed percentage has grown too — that is the increase you are entitled to, and it happens automatically without a decision.
None of this improves your view of the market. It decides whether you are still holding an account in a year, which is the precondition for a view being worth anything at all.
Lot sizes, contract values and margin requirements are set by the exchanges and revised periodically — check current specifications before sizing anything. The percentages above are illustrative conventions rather than recommendations. This is educational material, not advice, and nothing here recommends any position. We run no tips group and no signal service, we manage nobody's money, and no return is promised. A sold option can lose considerably more than the amount blocked against it.
Disclosure: the account-opening link on this page is under Atul Shrivastava's Zerodha Authorised Person registration (NSE AP Reg: AP2516003481; Zerodha Broking Ltd. SEBI Reg: INZ000031633) and earns a revenue share. TheFinBaba is not a SEBI-registered Investment Adviser — this content is educational, not investment advice.
Frequently Asked Questions
Should I size an options position by the margin required?
No. Margin is collateral against expected movement, it changes on its own when volatility rises, and on a sold position the loss can exceed it. Size against the maximum loss, which is a known figure for bought options and spreads.
What if one lot is more than my risk budget?
Then the correct number of lots is zero. A lot cannot be divided, so there is no smaller version of the trade. Index contracts, spreads or simply waiting until the account is larger are the honest alternatives to taking a risk you have already judged too big.
How much of my account should one position risk?
One to two percent of trading capital is a common convention, and having a fixed figure matters more than which figure you pick. Also set a limit on total open risk across positions, because several positions on the same index are closer to one position than to several.
Can I size a naked sold option properly?
Not honestly, because the calculation needs a maximum loss and an unhedged short option does not have one. You can convert it into a defined-risk position by buying a protective leg, which is the strongest practical argument for spreads over naked selling.
Should I increase size after winning trades?
Not deliberately. If you size by a fixed percentage of the account, the rupee amount grows automatically as the account grows, which is the increase you have earned. Raising the percentage after a good run is how a year of work is returned in a fortnight.
Related Reading
- Why a monthly target breaks sizing
- What margin actually is
- Capping the loss with a second leg
- How the strike changes the maximum loss
- The same arithmetic for a trading system
- Sizing taught as the closing module
Disclaimer: TheFinBaba provides educational content only - this is not investment advice. Trading involves risk of loss.
