When investors begin trading options, one of the issues they face is how to effectively put limited funds, typically defined as $5,000 to $20,000, to work in a volatile and risky marketplace.
Compared to stocks, options prices tend to move more quickly, not so much on a dollar to dollar basis, although that’s possible, but more so in percentage terms. It’s not uncommon to see a stock move 1% while at-the-money options move 10% or more.
With these issues in mind, the small account investor should utilize specific strategies to increase the possibility of early success.
What Are Options?
Stocks are securities that typically represent partial ownership of corporations, and are primarily traded via brokerages.
Options differ from stocks in that they are derivatives that give the holder the right, but not always the obligation, to buy or sell an underlying asset like shares of stock, exchange-traded funds (ETFs), or other securities.
How Do Options Work?
Calls and puts are the two types of options.
Call options give the holder the right, but not the obligation to purchase an underlying asset at a specified price on or before a specified date.
Put options give the holder the right, but not the obligation to sell an underlying asset at a specified price on or before a specified date.
A call buyer is bullish on the underlying security, while the owner of puts is bearish.
Options can be traded individually, i.e., simply buy calls or puts, or in combinations that include buying and selling calls and puts as part of a bigger, more complex strategy.
Investors learn more about options trading for beginners guide to understand the basics.
What Is Considered a Small Account for Trading Options?
There is no clear-cut definition of a small options trading account. Some might say a $20,000 account size is small, while others would describe a $5,000 account as small.
An individual can trade options with just a few thousand dollars or even less. Trading with a small account does not mean you cannot perform complex strategies or even make large profits.
Advantages of Trading Options With a Small Account
A small options account size still lets traders manage large positions by using leverage. An options contract typically covers 100 shares of the underlying security, so a trader can put down a small sum of money to benefit from material positions.
Another advantage for small options trading accounts is that an investor can get exposure to stocks with very high share prices by owning lower-priced options. For example, maybe you want to buy shares of a company with a stock price above $1,000, but you only have $800 in your account. You can buy an options contract that might cost just a few hundred dollars (or less), yet you will have exposure to large amounts of the stock.
A final advantage is that you can also make bearish bets on the stock or even non-directional wagers using combinations of calls and puts — even when trading options with a small account.
Recommended: Margin vs. Options Trading
Risk Management Strategies for Trading With a Small Account
Even small option trading accounts can have effective risk management strategies. It’s important to understand how position sizing plays a role in your portfolio. An investor should set parameters to control risk.
A common risk management rule of thumb is to risk no more than a set percentage of the portfolio’s value (e.g. 5%).
Position Sizing Example
There are no hard and fast rules regarding position sizing. The investor needs to trade off position size against number of positions. If the overall account has $1,000 in it, the positions may approach the 10% range allowing you to hold 10 positions of $100 each.
As your account increases in size, you might lower the position size. Therefore a $20,000 portfolio might have positions in the 5% range or 20 positions of $1,000 each. It’s entirely up to you and your risk tolerance. Eventually, you’ll want to settle in on a fixed percentage position size you’re comfortable with.
Today’s trading landscape offers more to traders with a small options account. It used to be that trading with such a small dollar amount meant that commissions and bid-ask spreads would make trading uneconomical. Now, however, commissions may be small to even non-existent.
Finally, user-friendly options trading is here.*
Trade options with SoFi Invest on an easy-to-use, intuitively designed online platform.
*Check out the OCC Options Disclosure Document.
7 Small Account Trading Strategies: Trade Management
Let’s review seven common options strategies for small accounts.
Scalp trading describes short-term methods to produce frequent, small profit trades. Using liquid options is important when scalping since a large bid-ask spread can cause a small profit to turn into a loss.
Scalping can work best with at-the-money or in-the-money options since options that drift too far out of the money might move slower due to a lower delta.
More sophisticated strategies like long strangle options are risk defined strategies betting on a large movement on the underlying asset. The trade is made at a net debit, so the most you can lose is the premium paid. If the stock indeed moves up or down in a big way, a long strangle reaps rewards.
Iron condors and butterflies can be used instead of short straddles to help define risk for credit spreads.
3. Profit Target
Defining a profit target helps determine when to exit winning trades. For example, if your account size is $1,000 and your position size is 10%, then a $100 trade might target a 50%, or $50, gain before exiting.
It’s wise to be mindful of your profit target in dollar amounts since commissions and slippage might eat too far into a profit target that is too low.
4. Stop Loss
On the downside, defining a stop loss helps to exit trades systematically. You might also want your stop loss to be well shy of a single trade’s maximum loss potential. A percentage of your maximum loss can make sense, perhaps 30% or 40%.
5. Time-Based Exit
A time-based exit strategy defines how long you hold an option. If the position has not moved in your favor after two weeks, as an example, then your rule could be to exit the trade and move on to other opportunities. Be wary of attempting to time the market, though.
Another idea is to end the trade if you have achieved a specific percentage of your profit target in a brief period.
6. Delta-Based Exit
Delta is one of the “Option Greeks” and it measures an option’s sensitivity to price changes in the underlying asset.
A delta-based exit is used when an option’s delta gets too high. For example, when a delta jumps from 10 to 30, a small move in the stock will move the option in a big way. Hence, your position size should drop, or it might be prudent to simply exit the trade altogether.
The same logic works if the delta gets too low — it then takes too large of a move in the underlying asset to materially move the option price.
7. Time Decay
The time value of an option decays at an accelerating rate as expiration nears. The upshot is that options nearing expiration can exhibit big moves up or down. Trading with a small options account can take advantage of enhanced volatility with short-term options — such as weeklies — but a lower-risk strategy would be to close out options trades before expiration week.
Tips for Small Account Options Trading
There are several strategies for trading small sized options accounts. These tips can go a long way toward building a successful options trading process.
1. Be Constant
Methodical actions and ways of thinking may promote successful and disciplined trading. Not having a set of guidelines that works for you might cause you to trade haphazardly, leading to emotional trading which can be destructive to growing your account size. Your position size as a percentage of your portfolio should be constant as your portfolio balance changes.
2. Highly Liquid Options on Highly Liquid Stocks
Be sure to pay attention to bid-ask spreads of the underlying assets you are trading. It’s wise to only trade options that have narrow spreads. Stocks and ETFs with thinly traded options often have wide differences between prices at which you can buy and sell, so trading an illiquid security effectively costs more money because of slippage.
The term slippage describes when your trade’s execution price is far away from the bid-ask midpoint. Slippage refers to losses that occur when trading large amounts of an asset with low liquidity. The lower the slippage, the more competitive pricing you’ll receive.
Options on large-cap stocks and the biggest ETFs, including index options, usually feature more liquidity. Also, high-volume securities might be good candidates for options trading. Volatility can increase bid-ask spreads, so simply trading options on the most volatile securities might not be the best move.
3. Risk-Defined Trades
Risk-defined trades are those where you know how much you can lose at the onset of the trade.
Naked strategies, on the other hand, feature possible losses that exceed your account size. These losses would be incurred if the market moves against you and options you have sold get assigned and exercised. For now, stick to buying and selling calls, alone or in combination.
Net debit purchases on combinations define your risk since you cannot lose more than what you paid for the trade.
It takes a disciplined approach to manage and grow a small options trading account. Defining risk objectives and setting rules can go a long way toward taking your account size to the next level.
It’s not about getting rich overnight — patience and a systemic focus on strategies that control risk may help you build your account value.
If you’re ready to try your hand at options trading, You can set up an online investing account and trade options from the SoFi mobile app or through the web platform.
And if you have any questions, SoFi offers educational resources about options so you can learn more. SoFi doesn’t charge commissions, and members have access to complimentary financial advice from a professional.
Photo credit: iStock/FG Trade
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Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
Exchange Traded Funds (ETFs): Investors should carefully consider the information contained in the prospectus, which contains the Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or by email customer service at [email protected] Please read the prospectus carefully prior to investing. Shares of ETFs must be bought and sold at market price, which can vary significantly from the Fund’s net asset value (NAV). Investment returns are subject to market volatility and shares may be worth more or less their original value when redeemed. The diversification of an ETF will not protect against loss. An ETF may not achieve its stated investment objective. Rebalancing and other activities within the fund may be subject to tax consequences.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.