definition of risk

  1. 3,036 Posts.
    thought this deserved its own discussion....

    What is risk?

    Risk is all a matter of perception. I have traders in #trade who refuse to write options because they say "risk is unlimited". Risk is a double sided coin. They think of risk as the maximum possible loss, regardless of probability. I prefer to think of risk in terms of probability of loss.

    In the insurance business, risk is determined by multiplying the probability of loss by the maximum possible loss.
    Eg chance of loss = 0.05, max loss = $10k....risk = 0.05 x 10,000 = $500.

    Traders should do the same, but we dont.

    Play the Odds. Sure a casino *could* lose a million bucks in 1 night.......but the odds aint very high. Casinos make money cos the house edge eventually wins. Ever seen a casino go broke? Writing options is the same deal. I have seen statistics that option writing has 60% chance of success, on dollar basis. Obviously this means the option buyer has a 40% chance of success.
    You quite often hear people say "80% of options expire worthless" which might be true......but they forget that the 20% that dont expire might have gone up 300%.

    How do YOU define risk?
 
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