Capital allocation is simply the process of determining how much money to commit or allocate to any one trade. In this case, to an options trade. More than likely, if your reading this, you’re familiar with the capital allocation process. Possibly you’re earmarking a few dollars for an upcoming trip or maybe you’ve just decided whats for lunch. Whatever the case, capital has been “allocated” or reserved for that specific item or situation.
When investing or trading, the astute practitioner will have always allocated capital in a healthy manner prior to placing a trade. Furthermore, it should come as no shock to know that this trader will far outlast his more reckless trading peers.
Typically, capital allocation is determined by calculating the account size by a small percentage amount. This yields a value that is both small enough to avoid catastrophe but large enough to make the trade worth the effort.
As an example, many traders take a simple approach to capital allocation. By multiplying their account value by 1-2% they’ve determined at what level they can initiate a trade.
I.E. Suppose a trader has a $34,400 account size. They may allocate capital as follows;
$34,400 * .01 = $344.00
Meaning, the maximum amount they would invest or trade on any one position would be $344.00. That seems simple but its fairly common for traders to avoid this all to important step.
As such, at OptionID it will be common practice to see our hypothetical allocation criteria within each OptionID’d.
For those that don’t trade options, please visit our sister site TickerID.com via the link below.