WEBVTT
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after seeing all the potential spreads we
can trade and after learning how to
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trade options and how to profit from them one of
the key questions for any option Trader is okay
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what size should I use for a particular
trade should I go all-in is 10% of
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my portfolio my bank account or
use Skype percent and their minions
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first two that I guess everyone on the
internet will answer the question differently but the
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core idea is that we want to develop
a system that will allow you to trade
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without going bankrupt I mean we are losing all of
your money and at the same time while maximizing The
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Profit so they the core idea is that there are
no perfect strategies even though if you develop your
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own strategies you will realize that you will fail
sometimes a strategies have a certain amount of failures
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and September of successes so if
you can measure or estimate they
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are the successful of your kind
of strategy we can always design
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a position size that is optimal for it
that will deliver the biggest profits while
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keeping your account out of bankruptcy
now so this is a question
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that has been researched for many many years
either particular gamblers now if you look at
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poker players and professional gamblers people that used to
play in the casinos they always wanted to come
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up with systems and methods and it is and
it's very interesting because as you know by
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now all of those games have negative H the
H is all negative so there is no system
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to play them because they H is negative
however we as option Traders we have
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access to positive Edge systems so
the idea is to leverage the
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fact that the age of the strategies positive and
the couple with a system that would allow
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us to size position luckily for us this
work has been done many years ago
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probably in the 50s and 60s I forgot exactly
when it was done by a researcher at Bell
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labs and and this person he come
up with the correct way I mean
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from mathematical rigorous way of
playing a particular strategy
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and and the whole strategy is called the Kelly
Criterion so the click I Tyrion is one
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way is as a very simple formula that will
help you Dimension your trades based on the spec
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tations for the probability of winning probability of
losing and how much money your pick
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as you can see here in this particular slide this is
the formulation of the click Italian is called the fraction
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f f is the fraction Kelly fraction
and it's so simple as a the
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mathematics behind it is very simple of course
the assumptions behind the this fraction is
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that it's all or nothing that's what
it is you you bet $1
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you a make something or you're losing $1 so
so this the kind of assumption that the whole
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mathematical framework is based on which Maps really
well into the option plays we do we
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when we do or option two is we are risking all
capital basically we are just entering and exiting so and
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and even if you don't do that any strategy can
be adapted to confirm to the assumptions of the
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clear criteria so without further Ado the formula is
the one that you see on the screen
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is basically the product of something
called the payoff times the probability
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of winning minus the probability
of losing / Lydia so
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so let's look at the product is what is p and q p
and Q are compliment that you always add when the priority of we
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need to always compliment the probability of losing for
one know the one component so you have 50%
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chances of winning then you have 50% chances of
losing you have 60 percent chances of winning
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you have 40 percent chances of vision
and so for instance the only
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quantity that is a little weird in that equation
is be the payoff what is v v is
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is you know for gamblers is a concept
that is easy to understand is the
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is the how much money they ought to know how much money
you're being pay for every dollar you have risky now so
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if I say they play that game where I for
every dollar that I that I put the give me
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to be is one it's not this
B is the net profit over the
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risk okay so if I am please give one
dollar and they are giving you act too
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it means that I got $1.00 in profit so B is 1
so so for instance let's say that you're doing like a 3
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to 1 so when is paying you three dollars
for every dollar Sobeys to just subtract one
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from they multiply no that's how it
works and then you do the formula
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and it gives you a fraction it is 0-1
know or even more than one and you will
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tells you how much you can risk from
your portfolio and it really helps if
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we do we see these with a real example and
this example is based on the in DNA is
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strategy that we use now or proprietary strategy
that is done with options in SPX
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and long-term numbers for this strategy for
the past year has been around 70%
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success probability of winning which is substantially high
and therefore the pilot of the since
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30 percent that is here and then
we can assume a worst-case scenario be
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V varies a lot by we can use
the worst case scenario because with this strategy
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where we have the maximum price we pay for a
position is two dollars and the maximum gain for
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the position is 3 I mean five
in total then B is 1.5 know
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where risk in one point for every dollar
that we are risking we are receiving 1.5
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so if we do the whole thing you'll
notice that if the fraction comes around 0.5
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or 50% what do you think is that
according to the clinic the Kelly Criterion
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that this is strategy usually use half
of your total account to settle bankroll
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every time you play it this is of course it makes no
sense because if you have two percent probability of losing you can
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yeah the thing is you cannot lose twice in
a row no and that's the thing the
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listen twice in a row maybe is a small but it's
nonzero so you could go bankrupt if you you follow
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Kaylee exactly to the lip what happens
is in real life many firms and
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banks have professional Traders use the Kelly Criterion to
give you an upper bound of your position size
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so now we know that 50% is the maximum
amount that will risk on this strategy but
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usually people tend to risk a fraction let's say
half of it so we could at least 25%
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or anything lower than 50 by 50 is the optimal but
in my case in particular I will not be comfortable
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with 50 because he'll I go by room in
tune if it to trace them work I'll go
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bang but that's how it works so
hopefully this short discussion about position
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is very helpful and hopefully you use
it to your advantage and I know
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in your mind you have a lot of questions okay what is the
probability of winning how do I determine the probability of winning well that's
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something that has to come from either an
estimation you are estimating in this particular trade
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what is the probability of winning or you have done
this for a long time by two or three years
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and then you can see in the past what has you know how many
winners you have had and you can see where the probability of winning
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is so something that is measurable definitely could be measured and
it could be measured in the Horizon and your web
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that mean you went to this for a
whole year it can be measured for us