Many people don’t invest in options because they don’t have the right amount of investment capital. When they see options on stocks such as Apple, Tesla, and Facebook they get intimidated due to the premium pricing.
However, this shouldn’t discourage you from options trading completely. Keep reading to find out everything you need to know on how to trade options with a small account.
Success Stories Of Options Traders
Let’s start on a positive note so that you can be motivated to trade options even if you have a small account. There are many people out there who have found success with little money and investment knowledge. Avoid using loans to fund your trading account due to the potential risks associated with losing the money you invest. This would expose you to collections by debt collection agencies like Northwest Financial, or Portfolio Recovery Associates if you are unable to repay the loan installments. Ultimately this will negatively affect your credit score. The risks outweigh the potential rewards.
For example, a Reddit user with the name WSBgod claims that he had made millions of dollars from options trading through the Tesla stock. Here is how it happened.
Apart from this, there are many success stories using a Robinhood account to trade options with little money. You can use these stories for inspiration so that you can successfully start trading as well.
Options Trading Basics
You need to first understand the basics of options trading. Once you have a solid base of knowledge you can build on it to be successful. Here are some common options terms that you need to know:
Call Option
This option gives the buyer the right to purchase a specified number of securities at a specific price until its expiration date.
One of the most simple and effective ways of trading options is call buying. This is because it can generate a high return on investment (ROI).
Put Option
This option gives the options holder the right to sell stocks at a specific price. You can think of this option as insurance in case a stock starts to decline in value.
Options Spreads
It is a trading strategy where a trader can purchase and hold multiple options of the same type. This strategy can include call or put options with the same underlying security.
There are three types of options spread strategies:
- Vertical Spread: This spread has two options. They have the same expiry date, however, they differ in their strike prices
- Horizontal Spread: This spread uses long and short options. They have the same strike price, but they differ in their expiration date
- Diagonal Spread: It allows you to enter into long and short positions at the same time with 2 options of the same type. However, they can differ in their expiration dates and strike prices
Expiration Dates
These vary depending on the derivative that is being traded. However, when it comes to options trading, the options expiration date in the U.S is the 3rd Friday of the contract month.
It can also be the month that the contract will expire. If the 3rd Friday of the contract month falls on a holiday, then the expiration date is one day before i.e. Thursday. After the expiration date has passed, the contract is rendered invalid.
Common Strategies To Trade Options With A Small Account
If you have a small account with little money and you still want to trade options then here are a few strategies you can implement.
1. Use Leverage
Utilizing leverage will allow you to trade markets that you can’t trade in using cash. Usually, your individual stocks require you to trade 25 to 30% of the cash value.
However, when you trade the same stock in highly leveraged markets then you only need 25% of the total trade value in cash. This should only be used to reduce the margin requirements of the trade so you can trade with little money.
2. Make Risk Defined Trades
It is important to be smart about your strategies when it comes to trading options with a small account. You have to utilize risk defined trades at first. Don’t trade using complicated strategies such as short strangles or short straddles.
These strategies are not for beginners because if the trade moves against you then you will take a big loss. So, a good risk defined trade is executed by using an iron butterfly or a calendar spread. Both these risk defined trades can be fruitful for a beginner with little money and a small account.
3. Perfect Your Timing
Having the correct timing is essential because the market is volatile and fluctuates every day. It is all about catching that one ‘price burst’ to make a profitable month or even a year. However, many people make the mistake of buying options at the wrong strike price and most importantly at the wrong time.
Experienced options traders are always looking for big moves in the market. With a greater than expected move (GTEM), you only need to be right 1/10 times to make a huge return on your initial investment.
If you do this right, you can take your account to the next level even if it has a low balance.
4. Practice Options Trading With Fake Money
Practice makes perfect. This is true for every aspect of life and even options trading. You can keep practicing with a demo account to get the hang of how options trading works. Many platforms offer this option and you can gain valuable insights and experience through this method without risking your cash.
You can easily open an account with fake money using these top 5 platforms:
- Investopedia’s Stock Simulator
- Thinkorswim
- TradeStation
- eOption Paper Trader
- Firstrade
Once you have gotten the hang of options trading on these platforms, then you will be more prepared to use real money to trade.
5. Research
You have learned how to trade through fake money accounts and you are ready to trade with real money. However, before you do that you need to do some serious research.
For this, you should first pick a few publicly traded companies and stocks. For example, you can research companies such as Procter & Gamble, Pfizer, Google, Tesla, Apple, and many more.
Keep an eye on their stock prices to see how they react to market conditions. You can use this information to conduct research on different trends and then compare them.
Apart from that, you should also make it a habit to stay updated on the recent news about the company. Whatever happens inside a company will have an impact on its stock prices. Eventually, you can make predictions when certain events occur and understand how the stocks react to it. You can also use tools that predict and forecast market conditions to help you understand.
This will go a long way when you are trading options with real money as you will be able to make much more accurate predictions once you understand how the market works.
You can also register at Robinhood and check the current options available to invest in the companies you have chosen. It is an amazing platform that will help you trade options with little money.
6. Stay Consistent
Nothing worthwhile happens instantly. You have to be consistent when trading because you will not make profits with just a few tries. Even if you make a loss at first you still need to keep going if you want to be successful. This will just help you become more experienced and build up your skills.
Common Mistakes To Avoid While Options Trading
Many beginners who trade options with a small account make mistakes often. As a newbie, you should avoid these at all costs:
1. Choosing The Wrong Expiration Date
Yes, there is such a thing as choosing the wrong expiration date and this is why you need to be careful. There are so many choices that you may feel overwhelmed while choosing. However, as we mentioned before, timing is everything.
To choose the right expiration date you need to:
- Interpret market action (volume and price)
- Analyze performance data, business trends, and financial statements of a company
Proper research into options you are targeting will help you choose the right expiration date that will eventually support your options trade.
2. Failing to Plan Ahead
Planning is the first fundamental step you need to take when it comes to trading options successfully. Always have a plan for every situation and make corrections when necessary. This way you will minimize your risk and your losses.
The greatest asset in trading options is having great analytical skills. Once you analyze the market and the options available, you can create the perfect strategy for what you want to achieve. However, as market conditions change you should review your plans to make it suitable for the current market.
3. Ignoring Volatility
To be successful at options trading you need to understand implied volatility. This is the measure of what the future of the market is in terms of volatility when it comes to a specific security.
You need to have the mind and obtain skills to recognize if the implied volatility of a given security is low or high. It helps in determining what the price of the option premium will be.
Premiums can vary in pricing so you need to determine the best strategy for each situation. For example, if the options are expensive then you can look at credit strategies. On the other hand, if the options are cost-effective then you can look at debit strategies.
4. Never Double Down To Make Up For Losses
The strategy of doubling down on losing trades almost never work the way you want. You need to understand that options are derivatives. This means that their prices move differently than the underlying asset or stock. Instead of doubling down, you should just close the trade. This way you will be able to cut your losses and you can find another opportunity that makes sense.
Final Words
It is not difficult to trade options with a small account. You just need to be smart about it and understand how it works. Having the right information is important if you want to be successful at anything in life. Also, remember to keep your emotions under control while trading and avoid unnecessary mistakes.
