Building Shock Absorbers: From Playground to Portfolio

The call from his teacher caught me off guard. My son had been bullying other kids in class. When I confronted him at home, he broke down crying. Through his tears came the explanation: “My friends told me to do it. They said they wouldn’t be friends with me if I didn’t.”

Maybe he was trying to dodge responsibility. Kids often do. But those tears, that raw fear of losing friends - it took me straight back to my own school days.

I was that kid once, sitting in the school cafeteria, laughing at jokes that weren’t funny, going along with things that made me uncomfortable. My “friends” knew they had leverage. When your entire social world revolves around one group, you’ll put up with almost anything to keep your place in it. The math is simple: lose these friends, and you’re alone.

Looking at my son now, tears streaming down his face, I saw the same trap I had fallen into decades ago. Whether he was telling the truth about his friends or not didn’t matter. What mattered was that I recognized that familiar fear - the anxiety that comes from putting all your social capital in one place, with no backup plan, no other circles to turn to.

This pattern - of concentration creating vulnerability - isn’t just about schoolyard dynamics. It’s about how we manage risk in every aspect of life. I found this idea crystallized in the following tweet:

Risk management continuum very bluntly stated:

1. Rules for cutting risk when you lose (P/L memory)
2. Rules for how big you can be constrained by aggressive portfolio shock assumptions (ie no P/L memory but positions that can lose X% AUM not allowed)

I’ll just say from option trading context #2 is preferable because the best opportunities likely occur when everyone else is constrained by #1 But that framework is not typical, harder to implement and will often make you feel like you are leaving $ on the table But you don’t lose your business on an idio risk. There’s an irreducible amount of systematic risk already. Don’t make idio something that can take you out.

- Kris Abdelmessih

The Two Approaches

At first glance, this might seem like dry financial jargon. But strip away the trading language, and you’ll find two fundamentally different ways of handling risk in life.

The first approach is what most of us do naturally: we get burned, we pull back. A bad relationship makes us hesitant to trust. A failed business venture makes us gun-shy about starting another. We let our past losses dictate our future moves.

The second approach is different. Instead of looking backward at what we’ve lost, we look forward at what we could lose. We ask ourselves: “What’s the worst that could happen?” Then we build systems to make sure we can survive it.

My son’s situation - and my own childhood experience - was a classic case of ignoring this second approach. We weren’t thinking about how to survive a worst-case scenario. We were just trying not to lose what we had, even when what we had wasn’t good for us.

Think about how these two approaches play out in everyday life. Take careers. Most people respond to a job loss by becoming more conservative in their next role. They take the safe option, the established company, the secure position. That’s the first approach - letting past losses guide future decisions.

But some people think differently. They ask themselves: “If I take this startup job and it fails, what’s my backup plan? Do I have enough savings? Could I get another job quickly? Do I have skills that transfer to other industries?” They’re not letting past failures constrain them. Instead, they’re building shock absorbers into their career.

The same pattern shows up in relationships. After a breakup, you might guard your heart and avoid getting too close to anyone. That’s approach one - memory-based risk management. The alternative is to build resilience into your life. Have strong friendships outside your romantic relationship. Maintain your own hobbies and interests. Keep your financial independence. Not because you expect things to fail, but because you want the freedom to make decisions without fear.

This is where the tweet’s final point about “idio risk” becomes crucial. In finance, idiosyncratic risk is specific to a single investment. In life, it’s any risk specific to one area - a job, a relationship, a friendship group. The point is: don’t let any single thing have the power to break you. Life already comes with enough unavoidable risks. Why add more by putting all your eggs in one basket?

Trading and Risk

Let’s look at how this plays out in investing. Most retail traders start with the first approach. They buy a stock, it goes down, they sell. The loss hurts, so they become more cautious. They might avoid that sector entirely or switch to “safer” investments. Each loss creates a new rule: no more tech stocks, no more options, no more small caps.

But successful traders use the second approach systematically. They start by calculating their maximum portfolio heat - the total risk they’re willing to take across all positions. Say you have a $100,000 portfolio and decide your maximum drawdown tolerance is 20%. That’s your systematic risk budget of $20,000.

From there, you work backwards. If no single position should be able to take you out, you might set individual position limits at 2% of portfolio value. But here’s where it gets more nuanced: that 2% isn’t your position size - it’s your risk per trade. A volatile stock might need a smaller position size than a stable one to stay within that 2% risk limit.

Let’s break this down with real numbers. Say you’re trading AMD:

• Portfolio value: $100,000
• Maximum risk per trade: 2% = $2,000
• Stock price: $200
• Your stop loss: 10% below entry
• Position size calculation: $2,000 ÷ ($200 × 0.10) = 100 shares
• Total position value: $20,000

Even though the position is $20,000, your actual risk is capped at $2,000 because of your position sizing and stop loss placement. This is portfolio shock management in action.

The framework becomes even more critical with options trading. Let’s break down each risk component:

Position Sizing with Overnight Gap Risk: Stocks can gap significantly on earnings or news. A typical 10% stop loss becomes meaningless if a stock opens down 30%. For example, if you’re trading NVIDIA before earnings, historical data might show overnight gaps as large as 15-20%. Your position size calculation then becomes:

• Maximum risk per trade: $2,000
• Potential gap risk: 20%
• Position size: $2,000 ÷ 0.20 = $10,000 maximum position

This means even if you’re extremely bullish, you can’t take a position larger than $10,000, regardless of your normal position sizing rules.

Volatility Expansion Scenarios: Options traders must consider implied volatility (IV) expansion. Take a stock trading at $100 with 30% IV. A worst-case scenario might involve:

• IV doubling to 60% (common during market stress)
• Stock moving against you by two standard deviations
• Time decay accelerating through expiration

Your position size needs to survive all three happening simultaneously. If you’re buying calls with 45 DTE (days to expiration), and each contract costs $3.00:

• Maximum position size = (Risk tolerance) ÷ (Worst case loss percentage)
• If your risk tolerance is $2,000 and worst case is 100% loss
• Maximum premium outlay = $2,000
• Maximum contracts = $2,000 ÷ ($3.00 × 100) = 6 contracts

Correlation Risk Management: Markets often move in clusters. Having multiple positions in semiconductor stocks (AMD, NVIDIA, INTEL) multiplies your actual risk beyond individual position limits. A sector-wide shock affects all positions simultaneously.

To manage this:

1. Group positions by correlation (tech, financials, etc.)
2. Apply a correlation multiplier to position sizes
3. Reduce individual position sizes as correlation increases

Example:

• Maximum sector risk: 5% of portfolio ($5,000)
• Three semiconductor stocks with 0.8 correlation
• Individual position sizes reduced by √(1 + correlation)
• New position size = $5,000 ÷ (3 × √1.8) = $1,240 per position

This way, even if all positions move against you simultaneously, your total risk stays within parameters.

The beauty of this systematic approach is that it removes emotion from the equation. You’re not making decisions based on recent wins or losses, but on concrete risk parameters that protect your portfolio under various market conditions.

Building Resilience

When I look back at that conversation with my son, I see now that it wasn’t just about friendship or bullying. It was about learning to build systems that protect us from worst-case scenarios. Whether we’re managing a stock portfolio or building relationships, the principle remains the same: don’t let past scars dictate future decisions. Instead, look ahead and ask, “How can I structure this so I can survive when things go wrong?”

This doesn’t mean avoiding risk entirely. My son needs friends. Traders need positions. We all need relationships and careers and dreams worth pursuing. But we can pursue these things while building in shock absorbers - multiple friend groups, position size limits, diverse skill sets, emotional support systems.

The math might be more complex in trading, but the underlying logic is simple: there’s already enough unavoidable risk in life. Don’t add to it by letting any single point of failure take you out of the game.

This essay is part of my ongoing study of options markets and trading. Nothing here constitutes investment advice. I’m sharing my journey of developing a trading and investing framework that focuses on protecting against large drawdowns, as these significant losses are often what prevent successful long-term compounding. Always do your own research and consider your personal circumstances before making any investment decisions.