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Defined Risk or Undefined Risk Trades

Sarah Jones

Mar 19, 2023

defined vs undefined risk

A defined risk options trade is a trade where the maximum potential loss is known in advance. For example, when buying an options contract, the most a trader can lose is the premium they paid for the contract. This means that the risk is limited and defined.

In contrast, an undefined risk options trade is a trade where the potential loss is not limited and can exceed the premium paid for the options contract. For example, selling an options contract without owning the underlying asset can result in unlimited losses if the price of the underlying asset moves against the trader.

Here are the top 3 things to think about when considering risk or undefined risk options trades:

  1. Risk Management: It's essential to have a solid risk management strategy in place when trading options. Traders should be aware of the potential downside of their trades and have a plan to manage risk and limit losses.

  2. Trading Goals: Traders should consider their trading goals and risk tolerance when deciding whether to take on a risk or undefined risk options trade. It's important to have a clear understanding of the potential returns and losses of a trade and make a decision based on your personal trading objectives.

  3. Education and Knowledge: Before trading options, it's important to have a solid understanding of the options market, the Greeks, and option pricing models. Traders should educate themselves on the potential risks and rewards of different types of options trades and keep up-to-date with market trends and news.

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