The 6 Best Options Strategies for Small Accounts
Options trading is a popular way to leverage your capital and generate income from the stock market.
However, not everyone has a large account to trade options with. If you have a small account, you might face some challenges and limitations when trading options.
In this article, we will discuss how you can trade options with a small account as efficiently as possible.
What is Considered a Small Account?
There is no definitive answer to what constitutes a small account for options trading, but generally speaking, anything under $10,000-$20,000 is considered a small account.
Most brokers require a minimum of $2,000 to open a margin account, which is necessary for selling defined risk spreads.
However, small accounts can use a cash account to avoid PDT rules, sell cash-secured puts or covered calls, and buy naked options.
Drawbacks to Trading Options With a Small Account
Trading options with a small account has some drawbacks that can limit your profitability and flexibility. Some of these drawbacks are:
Limited strategies: With a small account, you might not be able to trade some of the more advanced or aggressive options strategies, such as selling naked options, straddles, strangles, or ratio spreads. These strategies require a lot of capital and margin, which can be prohibitive for small accounts.
Inability to sell naked options: Selling naked options is one of the most profitable ways to trade options, as it allows you to collect premium and benefit from theta decay. However, selling naked options also carries unlimited risk and requires a lot of margin. Most brokers will not allow you to sell naked options unless you have a large account balance and experience level.
Having to risk more of your account per trade: With a small account, you might have to risk a larger percentage of your account per trade than someone with a larger account. This can increase your volatility and exposure to market fluctuations. For example, if you have a $5,000 account and you want to trade a $500 spread, you are risking 10% of your account on one trade. If you have a $50,000 account and you trade the same spread, you are only risking 1% of your account.
Higher commissions: Trading options involves paying commissions to your broker for each contract you buy or sell. Commissions can eat into your profits and reduce your return on investment. With a small account, commissions can have a bigger impact on your bottom line than with a larger account. For example, if you are trading lower-priced stocks, your commissions will be a higher percentage per contract.
How to Trade Options With a Small Account
Despite the drawbacks mentioned above, trading options with a small account is still possible and profitable if you follow some guidelines and best practices. Here are some tips on how to trade options with a small account:
Trade defined risk trades: Defined risk trades are trades that have a limited and known maximum loss and maximum profit potential. Examples of defined risk trades are credit spreads, debit spreads, iron condors, iron butterflies, calendar spreads, etc.
Trade liquid stocks: Liquid stocks are stocks that have high volume and tight bid-ask spreads. Trading liquid stocks allows you to get in and out of trades easily and quickly without paying too much slippage or commissions. It also reduces your execution risk and improves your fill quality. Some examples of liquid stocks are SPY (S&P 500 ETF), QQQ (Nasdaq 100 ETF), AAPL (Apple), AMZN (Amazon), etc.
The Best Options Strategies for Small Accounts
Now that we have covered some general tips on how to trade options with a small account let’s look at some specific options strategies that are suitable for small accounts. These strategies are:
1- Credit Spreads
Credit spreads are one of the most popular and simple options strategies for small accounts. A credit spread is a type of vertical spread that involves selling an option and buying another option of the same type (call or put) with a different strike price and the same expiration date.
There are two types of credit spreads: put credit spreads and call credit spreads. A put credit spread is a bullish strategy that involves selling an OTM put and buying a further OTM put. A call credit spread is a bearish strategy that involves selling an OTM call and buying a further OTM call. Both strategies have a limited and defined risk and reward, which makes them ideal for small accounts.
For example, let’s say you are bullish on XYZ stock, which is trading at $100. You decide to sell a 95/90 put credit spread for $1.00, which means you sell the 95 put for $2.00 and buy the 90 put for $1.00. Your max profit is the premium you collected, which is $100 ($1.00 x 100 shares). Your max loss is the difference between the strikes minus the premium, which is $400 ($500 - $100). Your break-even point is the short strike minus the premium, which is $94 ($95 - $1.00).
To profit from this trade, you need XYZ to stay above $94 at expiration. If XYZ is above $95 at expiration, you keep the full premium as profit. If XYZ is between $94 and $95 at expiration, you make a partial profit. If XYZ is below $94 at expiration, you start to lose money. If XYZ is below $90 at expiration, you lose the max loss.
Credit spreads are great for small accounts because they require as little as $100 of risk (the difference between the strikes) and can generate a decent return on investment (ROI). They also have a high probability of success, as you only need the stock to stay above or below a certain level to profit.
2- Iron Condors
Iron condors are another popular and simple options strategy for small accounts. An iron condor is a type of horizontal spread that involves selling two OTM credit spreads of the same expiration date but opposite directions. The goal of an iron condor is to collect premium and profit from theta decay and/or range-bound movement.
An iron condor consists of four legs: a put credit spread and a call credit spread. For example, let’s say you are neutral on XYZ stock, which is trading at $100. You decide to sell a 95/90 put credit spread for $1.00 and a 105/110 call credit spread for $1.00, creating an iron condor.
Your max profit is the sum of the premiums you collected, which is $200 ($1.00 + $1.00 x 100 shares). Your max loss is the difference between the strikes minus the premium, which is $300 ($500 - $200). Your break-even points are the short strikes plus or minus the premium, which are $94 ($95 - $1.00) and $106 ($105 + $1.00).
To profit from this trade, you need XYZ to stay between $95 and $105 at expiration. If XYZ is within this range at expiration, you keep the full premium as profit. If XYZ is outside this range at expiration, you start to lose money. If XYZ is above $110 or below $90 at expiration, you lose the max loss.
Iron condors are great for small accounts because they allow you to collect more premium than a credit spread with the same capital requirements.
3- Calendar Spreads
Calendar spreads are another simple options strategy for small accounts. A calendar spread is a type of diagonal spread that involves buying an option and selling another option of the same type (call or put) and strike price but different expiration dates.
There are two types of calendar spreads: call calendar spreads and put calendar spreads. A call calendar spread is a neutral to bullish strategy that involves buying a longer-term call and selling a shorter-term call with the same strike price. A put calendar spread is a neutral to bearish strategy that involves buying a longer-term put and selling a shorter-term put with the same strike price.
Calendar spreads are great for small accounts because they generally only require a small debit to open and are easily adjustable. They also allow you to benefit from theta decay of the short option and implied volatility increase of the long option.
4- Iron Butterflies
Iron butterflies are another simple options strategy for small accounts. An iron butterfly is a type of vertical spread that involves selling an at-the-money (ATM) straddle and buying an OTM strangle with the same expiration date. The goal of an iron butterfly is to collect premium and profit from theta decay and/or range-bound movement.
An iron butterfly consists of four legs: a short call and a short put with the same strike price (the body) and a long call and a long put with different strike prices (the wings).
Iron butterflies are great for small accounts because they have a low max risk since they are defined risk and collect a lot of premium at entry.
5- Broken Wing Butterflies
Broken wing butterflies are another simple options strategy for small accounts. A broken wing butterfly is a type of spread that involves buying an OTM debit spread and selling an OTM credit spread with different widths and the same expiration date. The goal of a broken wing butterfly is to profit from theta decay and/or directional movement.
Broken wing butterflies are great for small accounts because they provide traders a lotto zone to potentially make a good amount of money for a small risk. They also allow you to benefit from theta decay of the short option and directional movement of the stock.
6- Buying Naked Options
Buying naked options is the simplest and most straightforward options strategy for small accounts. Buying naked options involves buying a call or a put with a certain strike price and expiration date. The goal of buying naked options is to profit from directional movement and/or implied volatility increase.
Buying naked options has unlimited profit potential and limited risk, which makes it attractive for small accounts. However, buying naked options is also extremely inconsistent and highly affected by theta decay.
Buying naked options is great for small accounts because they do not take a lot of capital to purchase and offer the potential for high percentage wins. However, buying naked options is also very risky and requires a lot of discipline and patience, as most of the time, they expire worthless or lose value due to theta decay.
Best Stocks to Trade Options for Small Accounts
The best stocks to trade options with a small account include those with high liquidity. High liquidity means that there are a lot of buyers and sellers in the market, which results in tight bid-ask spreads and fast execution.
Some examples of stocks that have high liquidity are ETFs (exchange-traded funds) that track major indexes or sectors, such as SPY (S&P 500 ETF) and QQQ (Nasdaq 100 ETF).
These ETFs have a lot of volume and options activity, which makes them easy to trade and cheap to buy or sell. They also have a relatively stable price movement, which makes them suitable for various strategies and scenarios.
Managing Risk With Small Accounts
Managing risk with small accounts is crucial for long-term success and survival in options trading. Risk management involves controlling your exposure to potential losses and preserving your capital for future opportunities. Here are some tips on how to manage risk with small accounts:
Be willing to accept max loss with defined risk trades: Defined risk trades are ideal for small accounts because they allow you to control your risk-reward ratio and adjust your position size according to your account size. However, they also have a downside: they can be hard to adjust or exit if the trade goes against you. Therefore, it is important to accept max loss with defined risk trades and not try to salvage or repair them if they go wrong. Accepting max loss means that you are willing to lose the maximum amount that you can lose on the trade without trying to avoid it or reduce it. This can save you from losing more money than you planned or getting into more trouble than you can handle.
Watch out for assignment risk: Assignment risk is the risk of being assigned on your short option before expiration. Assignment can happen anytime before expiration, but it is more likely to happen when your short option goes in-the-money (ITM) or near expiration. If you have a long option to cover your short option, such as in a spread or an iron condor, you have no net risk from assignment, as you can exercise your long option to offset your short option. Therefore, it is important to watch out for assignment risk and close your trades before expiration or before they go ITM.
Watch your position size: Position size is one of the most important factors in risk management, as it determines how much you can win or lose on each trade. Position size should be based on your account size, risk tolerance, and expected return. Ideally, you want to limit your max losses to 5% or less of your account per trade, to avoid one trade ruining your overall portfolio. If you are trading a covered call strategy you must pick stocks that have a low stock price if you have a small account.
How to Become a Profitable Options Trader
Options trading can be a rewarding and lucrative way to make money from the stock market. However, it also requires a lot of skill, knowledge, and discipline to succeed.
If you want to learn more about how to become a profitable options trader, you can join the HaiKhuu Trading community, which provides hands-on help from experienced traders and a daily live voice call where tons of traders interact and share ideas.
The HaiKhuu Trading community is a friendly and supportive place where you can learn from the best and improve your trading skills.
