Struggling to grow your small account?
You’ve come to the right place.
I’m here to teach you 3 options strategies for small account traders.
What makes a strategy good for a small account?
For starters, I don’t want any single trade to blow up my account.
Each one should be small enough so I can be comfortable letting the setup work, not feeling the need to fiddle with it.
Additionally, the trades should seek to maximize profit and minimize risk.
Not to mention they fit within margin requirements of a small account.
But before we begin, I want you to take a quick look at this training video about in-the-money options as it relates to our discussion.
Now that you have a good understanding of the concept, let’s turn to the first strategy starting with the simplest and moving towards the more complex.
1) Long out-of-the-money calls and puts
Most folks know about basic call and put buying. While you need options approval from brokers, it doesn’t typically require a margin account.
We know the basics- call options are bets the stock moves above the strike price by expiration, puts are bets it moves below the strike price by expiration.
What you may not know is that increases in implied volatility (option demand) benefit long options.
Implied volatility also tends to rise when stocks are falling.
So, when you buy put options on a stock, you tend to get two things working for you – direction and increases in implied volatility.
Long options are pretty straightforward. You buy at one price and try to sell at a higher price.
The amount you could lose is no more than the cost of the options.
However, call options have unlimited upside potential (since a stock can go to infinity), while put options gain profits as a stock falls all the way to $0.
Cons:These trades lose value for each day that passes known as time decay. So, you have to be right on the direction and the timing of the trade, which can be difficult.
Pro tip: Go out of-the-money and out in time
With a small account, I want cheaper options but not a lot of risk.
Going out in time reduces the amount an option moves along with the stock (known as delta), but increases the cost.
Going further out-of-the-money helps reduce the cost.
There’s no exact formula for doing this. I want to balance the two based on each trade.
2) In-the-money credit spreads
Credit spreads involve selling one option and buying another to cap the risk on the trade.
Putting on the trade, I get paid a credit, which is the maximum profit I can make if both of the options expire worthless.
My maximum potential loss is the difference between the option strikes minus the credit I received.
Here’s a quick example:
● I sell a call option contract at the $200 strike price expiring in 21 days and receive $5.
● Then I buy a call option with the same expiration at $205 and pay $3.
● The premium I receive is $5 – $3 = $2, the maximum profit
● My maximum loss is $205 – $200 – $2 = $3
● My breakeven price is $200 + $2 = $202
Maximum profit occurs if the stock finishes at or below the lower call strike prices by expiration. Maximum loss occurs if the stock finishes at or above the higher call strike by expiration.
Selling in-the-money credit spreads changes the risk/reward a lot
By going in-the-money, I can achieve a better than 1:1 risk/reward.
This trade works great for small accounts because it let’s me risk less capital.
I can set up trades where I may risk $25 to make $75.
The further in-the-money I go, the better the risk/reward, but the lower the odds of success.
The further out in time I go, the lower the credit.
The odds of this trade reaching maximum profit decrease as the credit increases (risk decreases).
Plus, you have a risk of assignment with these trades, making it vital to close them out before expiration.
These also tend to require margin accounts, which often come with minimum account balances of around $2,000, though this is not universal.
Pro tip: Don’t go for maximum profit
Statistically, you have a better chance of success taking the trade off at a partial profit rather than letting it run to expiration and targeting maximum profit.
If I only risk $25, and I can get even a $15 profit, that’s a 60% return on my capital.
I would much rather take that and try to get a win-rate over 70%-80% then shoot for a 1 in 4 or 1 in 5 chance of achieving maximum profit.
3) Out-of-the-money debit spreads
Out-of-the-money debit spreads work similar to in-the-money credit spreads with a few key differences.
With debit spreads, you buy the inner strike and sell the outer strike (credit spreads are the reverse).
Here’s the same example but for debit spreads:
● I buya call option contract at the $200 strike price expiring in 21 days and receive $5.
● Then I sell a call option with the same expiration at $205 and pay $3.
● The premium I pay is $5 – $3 = $2, the maximum loss
● My maximum profitis $205 – $200 – $2 = $3
● My breakeven price is $200 + $3 = $203
Highlighting the differences, you can see how this makes me the opposite side of a credit spread trade.
Similar to a credit spread, you can set these up for low potential losses vs high rewards. However, the same tradeoff exists between chances of success and risk/reward.
The same issues that face in-the-money credit spreads also work hut debit spreads. You often need a margin account to trade them and time works against you.
Pro tip: Favor low implied volatility
Increases in implied volatility work for you. These trades work well on stocks that are at the lower end of implied volatility when you look back over the past year.
Selecting the right strategy
Use your trading plan to decide which trading strategy works best for you.
Each strategy has its pros and cons. Review those to make sure you pick the one that aligns best with your setup.
One of the best ways to learn about aligning setups with option trades is my High Octane Options.
Here, you get to see how I trade the markets with live access to my portfolio and trading feed.
Click here to learn more about High Octane Options.