Perhaps like me, you've discovered a trade that seems to hit all the important parameters. It can be traded on a favorite vehicle; its capital requirements, including those you reserve for potential adjustments, fit your trading account; and the style fits your trading personality. There's nothing worse than a quickly bored day trader forcing herself to trade a slow-to-percolate monthly income trade or a sedate monthly income trader forcing himself to trade a weekly on a high-beta underlying. In the first case, the quickly bored day trader is likely to overtrade that monthly trade. In the second, fear might lead the sedate trader to abandon a trade that's working just fine.

Your trade fits your parameters, however. You're going to size up now that you've traded it in a small size for a number of months. It's performed as your back tests told you it would.

Hold on.

Have you back tested it in the larger size? If you haven't, your theoretical profit and losses might jump around in ways you might not be prepared to handle. You might as well be that sedate trader who tries to force himself into trading weeklies on a high-beta underlying.

Charts 1 and 2 demonstrate the same trade setup, just in a different size. The setup, as of the date these think-or-swim charts were snapped, would have resulted in a delta of -3.37 per butterfly for Chart 1 and -2.84 for Chart 2. Both trades appear sedate, then, and the shape of the charts and especially of the white T+0 lines demonstrates their similarities. For newbies, delta measures how much the profit or loss theoretically changes for each point move in the underlying. The T+0 line demonstrates the theoretical profit or loss at each price point on the current day.

Chart 1:

Chart 2:

If, after the trade was opened, the RUT continued climbing over the next day or two, the T+0 line suggests that losses will be minimal on both charts. It's nice and flat to the upside. Of course the amplitude of the Chart 2 tent is bigger than the first one: this is an 8-contract butterfly centered bearishly and hedged with DITM calls. Chart 1 shows the same butterfly, but with only 3 contracts. DITM calls also form the hedge here, but they're IWM calls because of the smaller size of that butterfly.

You've traded the 3-contract size for a number of months. You understand that the potential gains and losses are going to be larger with the larger position represented by Chart 2. You're ready for that difference. Or, are you?

These charts were set up on July 5. Imagine that by 7/10, the RUT had zoomed up to 845. We know that didn't happened, but the trader entering the trade on July 5 couldn't have been certain, and our charts show what that trader would have been testing on July 5. On July 5, then, the chart date has been rolled forward to July 10. A new vertical line marks the theoretical loss at 845 on each chart.

Chart 1 with Date and Price Rolled Up:

Chart 2 with Date and Price Rolled Up:

This is a situation that occurs quite frequently with this setup because the trade is initiated with the butterfly's center below the action. The DITM long calls hedge loss so that the butterfly can either be rolled up if the trader believes the upward movement will continue or the trader can hold on for a day or two to see if the price will pull back. The two trades again look quite similar. Each is working as expected. The trader who was accustomed to trading the size depicted in Chart 1 will know that the trade is working well.

Only there's a little wrinkle, and it's the size of the theoretical losses:
Chart 1: $326.59
Chart 2: $745.99

The trader accustomed to trading this trade would have determined that usually about the time the loss is this large to the upside this short of a time after entry, it's time to adjust in some manner. That adjustment can take several forms, depending on the trader's outlook, but the trader's observations through several months of trading this trade would have prompted that trader to be thinking in terms of "time to do something" when the loss as big as it is on Chart 1 at that point. Even if the trader adjusts based on the Greeks/butterfly, as I do, the trader would have a sense of how big a theoretical loss to expect at an adjustment point.

Only, Chart 2's loss is already much bigger. In fact, the $326 mark would theoretically have been hit when the RUT was at about $834, about 11 points earlier, when the trade might not have needed adjustment. Perhaps the trader watching the Greeks of the trade and adjusting based on the delta values at each level would not have reacted, but it can still be a jolt when a trade you expect to be down a few hundred is down by a much heftier amount.

We traders try to remove as much emotion as possible from the trading business, although I believe it's impossible and probably not a good thing to remove all emotion. Don't we want that gut reaction to warn us when we're taking on too much risk? However, the sheer amounts of the potential losses can be hard to handle without stress when the trader has sized up too rapidly.

I've heard of traders who trade a single-lot for a while and their losses amount to the cost of a nice dinner. They trade successfully through thick or thin and size up only when they've handled some difficult trading months by making profits, breaking even, or closing with a small loss that's well in keeping with the typical gain for that trade. Perhaps they size up gradually, too, but then one day that loss, while not at all outsized for the way the trade works, suddenly amounts to a car payment or maybe even a mortgage payment. It's serious money, and the stress attached to that loss can be serious, too.

The amount of the losses we can accept does not expand smoothly along with the size of our trading accounts, either. If you have $500,000 in a trading account, there still may never be a time when you're comfortable putting $125,000 on the line each month. Trading out of your comfort zone can lead to overtrading, making panicked decisions, and closing a trade that's not in trouble because you can't stand looking at the theoretical loss. Even worse, it can lead to not closing a trade that is in trouble because the loss is too big to accept.

I would urge special cautions about sizing up right now when implied volatilities are so low. It might be that we're about to enter a prolonged period of calm in the markets, one when implied volatilities will stay low or perhaps even sink more. Usually, however, when implied volatilities sink this low, there's risk that they may head the other direction. That kind of action can often be precipitated by some shock to the financial system that sends equities plummeting.

I would also exercise particular caution in sizing up right now if you've been trading only a few months or trading a new strategy only a few months, no matter what your outcomes with that trade. We've had difficult trading conditions produced by huge morning gaps that make it difficult to defend trades. However, we have not had a prolonged downdraft like the one that began last July since . . . well, since last July-August. Trading during one of those downdrafts presents challenges like no other.