If you have a small account and want to start trading options, you may be wondering where to start. In this article, we are discussing how to trade options in a small account to amplify gains and reduce risk. We will also give real examples using the tastyworks platform, touch on trade management and provide you with the most important tip when trading options! So be sure and read to the end!
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What amount of money is considered a small account for option trading?
There is no definitive answer to this question, but we would generally consider an account with a balance of less than $5000 to be small. Keep in mind that this number will vary depending on one’s opinion and how much money they have to trade. I recommend having at least $2000 minimum in order to be able to make a few trades.
Why trade options in a small account?
There are several reasons why you might want to trade options in a small account. One reason is options can give you the ability to control a large number of shares for a relatively small amount of money. This is especially helpful if you’re bullish on a stock but don’t want to risk a lot of capital.
Another reason is that options offer great risk-adjusted returns. This means you can make a lot of money on a small investment, but you are also taking on less risk than if you were to buy the stock outright.
Trading options in a small account can also help you to learn how to trade without risking too much money. This is a crucial step if you want to eventually become a successful options trader. The more trades that you get under your belt, the more you will learn.
What are the best option strategies for small accounts?
When it comes to trading options in a small account, the key is to find strategies that offer a good risk/reward ratio and will not utilize too much capital in a single trade.
Defined risk option trades are great strategies for small accounts. The potential loss is known in advance when the trade are palced. Some examples of defined risk option trades include Put spreads, Call spreads, Iron Condors and LEAPS.
Put Spread
Selling a Put spread is a bullish trade where you sell a put and buy a lower-priced put option. The maximum loss is the difference between the strikes minus the premium you paid for the options. We aim to collect 1/3 the width of the strikes when we sell put vertical spreads. The trade is best when IV (implied volatility) is high. We want the price of the stock to stay where it is at or move up before expiration.
The example below shows a 130/125 Put vertical. We sell the 130 strike and buy the 125 strike as a stop loss. The max profit is collected when we put the trade on. It is $177 in this case. The max loss is $500 – $177 which is $323.
Call Spread
Selling a Call spread is a bearish trade where you buy a call option and sell a higher strike call option. Your maximum loss is the difference between the strikes minus the premium you paid for the options. We aim to collect 1/3 the width of the strikes when we sell Call vertical spreads. The trade is best when IV (implied volatility) is high. We want the price of the stock to stay where it is at or move down before expiration. So we want to put this on in stocks or underlyings that we believe are overvalued.
The example below shows a 150/155 Call vertical. We sell the 150 strike and buy the 155 strike as a stop loss. When we put the trade on the max profit is collected. It is $192 in this case. The max loss is $500 – $192 which is $308.
Iron Condor
An Iron condor is a neutral trade where you sell two call options and two put options with different strike prices. The difference between the strikes minus the premium you received for the option trades is the maximum loss.
In the example below, we show a $5 wide Iron Condor in APPL. We collect $241 immediately when we place the trade. The $241 profit is kept as long as APPL stays between the 145 and 170 short strikes. This is a neutral strategy so we want the stock to stay within this range at expiration.
The max loss is $259 since we collected $241 and each vertical is $5 wide.
LEAP Option
Another great bullish strategy is to buy LEAPS. A LEAP is a long-term option that expires further out in the future than a regular option. For example, you might buy a LEAP with an expiration date that is 12 months away. This type of trade can be very profitable if the underlying stock goes up.
Here is an example of buying a Twitter Call 319 days out to expiration. The cost is $780. However, the reward is unlimited. TWTR is currently at $32.68 which is way below the 12 month high of $73. Twitter is a good business and if TWTR was to get back to that $73 within the next 319 days the gain would be $3525. That is a huge 451% return on investment.
Trade management in a small account
When you are trading options in a small account, it is important to manage your risk carefully.
You need to always have a plan and a set of mechanics or rules for how you will manage trades. Trade management in small accounts is really no different than in large accounts.
There are lots of great videos on trade management at Tastytrade.com.
When trading options there is one key tip that I recommend above all others. The most important key is to stay small and not risk more than you are willing to lose. I suggest keeping your BPR which is your buying power reduction to 50% or less at all times. The other 50% should be just sitting in cash.
So, when trading options trade size is always the most important factor to consider. You also want to make sure that you are not risking too much money on any one trade.
Final thoughts
As you can see, there are many different option trading strategies that are suitable for small accounts. Just remember to use these strategies when trading in a small account which will help to reduce risk and amplify gains. And be sure to stay disciplined with your money management rules. Most importantly stay small and don’t trade more than you are willing to lose.
If you follow these tips, you’ll be on your way to successful options trading so that your small account will grow into a larger account!
Thanks for reading! I hope this helped you understand better how to trade options in small accounts.
Are you trading options? If so, let me know which strategies you are using. If not, just let me know why in the comments below.
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