The Option Trader's Hedge Fund

“ Insurance companies sell 'paper,' a promise to pay in the future in exchange for cash now.

“ Insurance companies sell 'paper,' a promise to pay in the future in exchange for cash now. ” e.style.display='none');if(typeof getContentsSections==='function')setTimeout(getContentsSections,50)" /> The core thesis: sell options like insurance. TOMIC — The One Man Insurance Company — is the framework co-author Dennis Chen uses to run his hedge fund, Smart Income Partners. Just as an insurance company collects premiums for bearing risk, an options seller collects premiums from buyers who want protection on their stocks or indexes. The asset insured is the stock; the policy period is the option's expiration; selling out-of-the-money is like offering a deductible. TOMIC has three primary functions: 1. Trade Selection — the underwriting that determines which risks to take and at what price 2. Risk Management — position sizing, hedging, and trade adjustments 3. Trade Execution — efficiently placing orders on the option exchanges These are supported by a trading plan, proper infrastructure, and continuous learning processes. TAKEAWAY 2

“ AIG sold $450 billion of credit insurance without a clear understanding of how the risks behaved. ” e.style.display='none');if(typeof getContentsSections==='function')setTimeout(getContentsSections,50)" /> Underwriting separates survival from collapse. Hurricane Katrina caused $43.6 billion in insured losses from 1.75 million claims, yet the insurance industry survived and posted record profits in 2004 – 2006. Their underwriting was sound — they understood hurricane risk from prior events and collected adequate premiums. AIG was the opposite disaster. The company sold $450 billion in credit default swaps on mortgage-backed securities without understanding how the underlying risks were correlated. Unlike house fires, which don't spread between neighborhoods, mortgage defaults are contagious during recessions. AIG's underwriting was fatally flawed: wrong risk assessment, insufficient premiums, no portfolio-level risk management. Trade selection in your TOMIC must answer five questions covering market, direction, time frame, volatility, and pricing before any premium is sold. TAKEAWAY 3

“ Taking losses from identified risks is acceptable, but getting blindsided from unexpected risks is not. ” e.style.display='none');if(typeof getContentsSections==='function')setTimeout(getContentsSections,50)" /> Two predators kill trading accounts. The authors, borrowing from Dr. Alexander Elder, call them sharks and piranhas. The shark is one devastating loss — imagine 35% of your equity wiped out in a single trade. The piranha is a stream of small losses that slowly devour your capital, like piranhas killing a cow with a thousand small bites in the Amazon. Two rules neutralize both threats: 1. Never risk more than 2% of total capital on any single trade — this prevents shark attacks 2. If the portfolio loses 6% in any single month, stop trading for the rest of that month — this prevents piranha death With 15 – 20 positions and an 80% win…