Active Risk Management
by Richard Gard
The options market is often thought of as a simple directional play: Buy a call option if you're bullish or
buy a put option if you're bearish. But options can also be used to manage a position. Here's a real-life
example of a trade that started as a simple long future position, became a synthetic call option, mutated
to a long derivative strangle and (finally!) ended up as a dynamic put ratio backspread.
Often, traders using trend-following systems with passive risk management face day-to-day changes in
the markets' direction that can challenge the discipline of the best traders. After all, the global economy is
in a constant state of flux, and the markets generate a lot of noise. Constant whipsaws, volatile ranges and
politically induced price shocks have wreaked havoc with markets. The strong trends have ended with
sudden major reversals, giving many traders a serious reduction of open profits as stop-loss orders are
filled at terrible price levels. So what's a trend-following speculator to do when stop-loss orders are not
effective in controlling risk?
The answer is active trade management with exchange-traded derivatives. Derivatives or options
strategies in a toolkit can transform a position to fit the trader's particular risk tolerance and price
projection. Modeling position risk with options analytical software keeps one aware of the market in a
dimension other than price or volume. Active trade management keeps you focused on opportunities
through the use of option hedge strategies.