3 Ways to Trade Options with a Small Account

imagine you're the best poker player alive imagine you know the probabilities perfectly you know when the call bet fold whatever you know how the probabilities pan out this is called having positive expected value over time you should make money because you're playing the probabilities flawlessly but even still if you sit down with a tiny stack of chips if you get dealt a couple bad hands in a row you could be out of there you can go bust just by having a couple bad beats it's the same deal with trading if you sit down and you have a little tiny baby account you're gonna need a little luck to get by if you have a few bad trades in a row even if you're playing the probabilities just right because trading is very much a probabilities game you could blow up your account and that's just a fact so trading with the small account is tough you can do it but it is tough I think there are three ways that people tend to approach trading with a small account and in my opinion some more better than others but we're gonna cover all three of them the first approach is by just yoloing your money you only have 200 bucks what can you afford out of the money options they're cheap they provide you with a significant amount of leverage but really they're more of a gamble than anything because they have such high break evens and theta degrades such a large percentage of them that you really have to hope that the stock moves quickly I can't say that I haven't tried an earnings bet before when I was first learning options that's exactly what it did like three times in a row and I lost all my money even though one of the times they went the way I expected because implied volatility collapsed and it did not move far enough people buy out of the money options hoping that the stock price moves quickly because they know that time decay is gonna eat away at their premiums quite fast so the best way they think to do this is by buying before an earnings call but what some people don't realize is the expected move of the stock it's already priced into the premium of the option so you're paying more for this out of the money option and then once that expected move occurs if it's not outside if it's not more than what was anticipated if say people thought I was gonna move 8% options were priced in to reflect that kind of volatility and it doesn't move past 8% what ends up happening is even if it goes the direction you expected your premiums are going to collapse because implied volatility collapses people no longer want these options they don't expect any volatility coming up in the near future the binary event has passed your premiums collapse so the stock doesn't move quickly or if you get what's called IV crushed if implied volatility collapses which happens after earnings and that will diminish your premiums then you're out of money again that kind of scenario you have negative expected value you're not playing the probabilities correctly you're just hoping to get lucky and there was no worse feeling than betting money on an earnings play and then watching it just evaporate like my twin brother Eric he's my identical twin brother I remember one morning he was thinking of doing an earnings call and I was telling them please don't do it because I've done it before multiple times and none of the times has it panned out well I told him don't do it you'll always regret it it wasn't that much money that was betting at the time was like for 250 bucks but he was a college student so that's a lot of ramen and things didn't go the direction he planned and it's not just a coin flip it's a weighted coin flip cuz he even if it goes a direction you anticipated if implied volatility collapses too much you're still going to lose money you know don't take my word for it let me let me get him and actually let him tell you how you felt felt horrible if you're trying to take it seriously and you want to actually stay in the game for a long amount of time buying out of the money options as a trading strategy generally not gonna prove worthwhile yeah maybe you'll win more likely you'll lose so that's one approach is buying out of the money options another approach is trading spreads you only have so much to trade maybe you want to diversify your trades into a bunch of different underlyings well if you want to make options cheaper you buy call and you sell a call against it or buy put and sell put against it that's gonna reduce the overall cost to the trade it's gonna reduce the capital at risk sure it's gonna limit the max profit you can make but at least it's going to be cheaper and you can diversify your trades a little bit I think this is a fairly decent approach to trading in a small account but there are a couple issues with it the first is the bid-ask spread the bid-ask spread if it's really really small if you're really lucky it's going to be just a couple of cents wide but if you're only trading with 200 bucks that means to get in and out of the trade to buy it the ask and sell the bid or vice versa you're giving up two dollars per trade and that's one percent of your account so just to get in and out is going to be one percent of your account and this is assuming that you have positive expected value that you're gonna actually be trading well but as a beginner you're probably gonna have negative expected value which means you know right now you're probably gonna not be playing the probabilities correctly and you're going to be more than likely losing a little bit of money so you're eating away into your capital with the bid-ask spread and then you're also eating away into your capital because you're just trying things out you just and learning not only that but you're trying to have a nice plethora of diverse trades you're probably gonna be limiting your max profit quite a bit to make those trades cheap you have to sell a call pretty close to the call you bought or put whichever type of spread you're doing what that's gonna do is it's gonna reduce your max profit by a significant amount so the bid-ask spread is eating into your capital you probably have negative expected value which is going to eat into your capital and then your max gains on these trades is not gonna be that high anyway so is it really worth it so you can do it I'm not saying you can't and it's probably more likely that you'll be successful and at least be in the game longer than if you're trading out of the money options but I think the best way in my opinion is this third approach and that approaches don't trade options and I kind of hate saying that but once you save up enough money maybe you like get up to a grand you have so much more to play with you can handle having a few bad beats in a row you can handle the bid-ask spreads and you have enough time to practice the point where one might actually get positive expected value if you start with 200 bucks and you lose those 200 bucks in the next month you throw another 200 in and you lose most of that and the next month you know that throw another 200 and it's just you just restarting every month you want to have a nice juicy amount of capital play with so what I would suggest is just throw 200 bucks in your brokerage account and then the next month throw another 200 bucks in do it again and again again until you have about a thousand dollars in your account and then probably should still stick to spreads but then you can handle all the things we've just discussed sometimes the best answer is the least fun answer to here and that is exactly the one I'm giving you it's don't trade options right now save up until you have a nice pillowy cushion of cash so I know trading is all about being very active but sometimes there are moments where you need to be patient and this might be one of those moments in the meantime it doesn't mean you can't trade there's platforms like thinkorswim by TD Ameritrade where you can pay per trade all you want and you can practice all sorts of different strategies and take this time to learn what kind of trader do you want to be what kind of strategies do you want to try learn how different option strategies work what other people's approaches are to the market says everyone's approaches a little bit different thanks for watching guys I'll see you in the next one [Music]

Channel: InTheMoney

Views: 697,459

Rating: 4.9302082 out of 5

Keywords: Adam Answers

Id: 9l0O0UwR-es

Length: 6min 38sec (398 seconds)

Published: Sat Mar 28 2020