How to use Kelly Criterion in Options Trading for sizing?

Kelly Criterion in Options Trading

Kelly criterion is more of a winning formula than a prediction technique. Some many others trends and indicators are good for making accurate predictions. The market is actually flooded with a lot of them. That is why options trading takes another twist. There are many tools in use by the market forces out there. It is no wonder that they can spend a lot of money trying to predict where the trends will fall. That is not to reduce the impact of this important tool.


When you look at options trading, you may have the first impression that it’s all rosy. Well, you may have a point right there. But think about other possibilities. In other words, what about the possibility of losing out? Anyway, for now, what matters is that you should mitigate such losses. To make it simple, you have to be good at making an excellent prediction of your trading. If you want, you can even decide to use it to predict the losses to come your way.

Calculating your gains in advance

The marvels of probability will never end. In fact, they are there to provide a glimpse into the likelihood of an event taking place. This is where options trading brings in the aspect of being a smart investor. You cannot afford to wait for a loss before you start running around and asking how it all came about. In this case, you have a well-established formula to give you a good picture.

The formula is as follows:

K = \frac{bp-q}{b}

The main issue is how you need to use those parameters and what they stand for. First, K represents what is deemed as the kelly’s percentage or the portfolio to use. The letter b represents the decimal odds which can come up to 1. The letter P represents the probability of winning, while q represents the probability or chance of losing.


When using this formula, b is simply taken as a constant equal to 1. Then you can only be given the probability of winning, p. The other probability of losing q is calculated by subtracting p from 1. Thus,

q = 1 – p

If you have been given or you are able to estimate the probability of failure, the expression becomes;

P = 1 – q

There are some gains that you can take your time to calculate. But it would be best if you still made your prediction smart even when using such a tool. When you go into it the blind way, you will have more to worry about. In the end, the losses incurred usually reflect a part of your work that remains hanging. If you do not act on it, there is no chance that your options trading will work out.

Take your productions with your gut feeling if you can. But the bottom line is that you have to make calculations that will make a difference. These are the same calculations that will be there to make you look richer and better. If you continue trying options trading techniques in their variety, calculations are good. You will trade in a safer zone and there will be no chanting the losing hymns.

The main advantages you will get

Kelly’s criterion may have its main usage of giving you some reliable picture of your trading. But most traders want to know what is in it for them. Does it mean that options trading will also work for this scenario without too many changes? Using this formula, you are actually predicting what you stand to gain and how you can go about investing. The other way of looking at it is that you already have all the tools, but the route remains bleak.

The main advantage that comes with this criterion is that you save your hard-earned cash. In other words, you will not be a victim of blind trading like what is common among many people out there. If you want to save yourself the tears of investing with heavy losses, this is the way to go. But this cannot even work well for your options trading if you stop making calculations. That is why predictions based on facts are better than those that are not even based on any. You can predict what you want. But you need to make sure that you are ready to accept the reality of it all.


The other issue that works as an advantage is that you will know what you need to put in for your margin. There is no need to remain in the dark when it comes to making options trading your mainstay. You will have a good starting point that makes your work easy. The only thing that should not discourage you is the inflow of the main problems that actually work for you. Here you can balance up by including the possibility of error. The percentage can be there and it has to be small enough at the end of the day.

Who can use the formula?

The quickest response is that anyone can manage to use that formula. What if you have your own reservations that need to work in your favor? This means that you also need time to analyze such reservations and see if they are fine. But others have used the Kelly criterion on options trading techniques. This means that you are not going to start a new norm altogether. This has worked, and it continues doing so. All you can accept is that there is no need to work in line with other options that do not even add up much. In making the analysis simple, we can agree that any trader can use the Kelly criterion. After all, it works, and it has been in use for some time.

The correct expectations

You can indeed have all the benefits outlined. But, there is a catch to all this. If you have to use the formula for options trading, you also need to use the right parameters. It would help if you spent time collecting data. This is the same data you will need for options trading predictions. The winning part is only a small part, but the rest of the tools will be there to make you work hard.

To make the whole analysis sweet and short, you need to do your work before the actual calculation. Find the right parameters in time. Then you will stand a better chance.


Taking your ideas to another level

Now, this is where most traders need to take their time. You may decide to make your own predictions and calculations. But that is the beginning, and you have to make it interesting for you. There is nothing new about taking such decisions to another level aside from using them well. If you are not sure about using the criterion that well, you can consult and get some guidance you need. That is how it all works out. You can then enjoy options trading with its own features. But when you throw all caution to the wind, then your levels of risk will also rise. This can also be smart trading where you should have that knowledge of your options.


When you use the Kelly criterion, you lower your risk levels. In fact, options trading, it there to protect your investment and give you a good footing. There are also other trials and issues that should come to mind when you come to know about this same formula. In case you have some ideas about what should come first, this is the starting point. The days of using trial and error are gone and you can even try something else at the end of the day.

Suggested Reading

Kelly’s Problem from Ron Shonkwiler @GaTech

Optimal Position Sizing for options investment from Ron Shonkwiler @GaTech

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