Option Trading with Too Little Cash

Mark,

I have a very small amount of money invested with TDAmeritrade. I have some stocks, about 10, with varying amounts of each, but all under 100 shares.

In reading your book about options, I do not want to write covered calls or puts, but do want to use options to earn small profits from 1-5 contracts. Is the best conservative way to invest with options to buy a small number of contracts for an interesting stock or to start with collared positions to protect my money? Thanks for your response.

Teresa

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Hello Teresa,

Very sound questions.

A good and conservative method for protecting assets is to use collars. They offer a limited opportunity to earn cash, and that is one reason why I don’t believe they are currently a good choice for you. However, the point is moot.

To use the collar strategy effectively, you must own at least 100 shares of stock.

The collar is made up of three parts. Buy stock, buy put, sell call

You already own stock, but it is less than 100 shares

You are allowed to buy a put option because stock ownership is not required to buy puts.

However, you cannot sell the call option unless you own 100 shares (your broker will not allow it, and it is far too risky for you. If the stock rises too far, you can lose a lot of money. When selling one call option, you accept the obligation to deliver (sell) 100 shares at the agreed upon (strike) price. You don’t own those 100 shares. If the stock rises, you can easily lose money.

Part of the collar?

If you try to do part of the collar and only buy one put to go with your stock, that is ill-advised. First, it will cost more than you would be willing to pay. Next, you would own too much put protection. Remember that each put option allows you to sell 100 shares at the strike price – and you don’t own that many shares. Thus, unless the stock takes a very big move higher (to compensate for the cost of the put) or lower (allowing you to profit by owning more put protection than needed – this trade is going to lose money. And that’s going to be most of the time.

Buying options

As far as buying 1-5 contracts in an ‘interesting stock’ is concerned, you certainly can do that.

However, you are asking my opinion and I strongly believe that the chances of finding the right stock, at the right time, and buying the right option at the right price – are so tiny, that it is truly a very bad idea. But it’s a common idea. Vast numbers of individual traders do buy options, hoping for a miracle.

In addition, some brokers make it impossible to succeed. The commissions are so high that the small trader has no chance. Do you want to pay $15 to buy the options and another $15 to sell? If you make a profit of $50, all you get is $20. And if you lose $50, the loss becomes $80. The numbers are stacked against you.

Theresa – please think of what must happen: Your interesting stock must make a move in the right direction. It must move quickly because your option loses value every day. It must move far enough to compensate for the cost of the option and the time decay. Do you recognize how the odds are stacked against you? This is more gambling than investing. I don’t recommend it, but it is your money and if you want to gamble you can do so. But for someone who is concerned with using collars to protect assets, gambling should be the last thing on your mind.

My best advice

Avoid options until you have more money. Assuming you have an income, add to your savings every week or every month). When you have more cash available, and if you want to own 100 shares of a single company that is the time to re-think your choices. The collar is very conservative and not for investors seeking growth. If you seek protection of your assets, I’d suggest avoiding the stock market altogether.

Although age is not a determining factor, if you are young with your whole investing future ahead of you, I urge you to wait until you are better funded before using options. If you are nearing retirement, then I believe the idea of buying options is a bad choice. This is when you can ill-afford to be taking chances.

Repeating for emphasis: Buying options is speculative, no matter how interesting the stock may look. It is a way to make some big money – but the odds against success are very long.

I hope you make a satisfactory (for you) decision.

926

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12 Responses to Option Trading with Too Little Cash

  1. Scott 03/15/2011 at 7:23 AM #

    My 2 cents. I have recently started transitioning from paper to money, day trading, and I have very limited capital to start with. With such a small account, trading the actual stock of anything that I happen to like is nearly impossible. So what I have done is put together a list of stocks with options that have very small spreads (5 cents or less). With that list I do my daily scans and day trade options contracts using a discount brokerage. I pay $5 in and $5 out, so with the spread added to the equation, I am not down too much when I open my trades. With strict risk management rules, you can make it work.

    • Mark D Wolfinger 03/15/2011 at 9:02 AM #

      Scott,

      Thanks for sharing. I wish you well.

  2. Lies 03/15/2011 at 10:55 AM #

    I think buying calls is not too bad IF you buy leaps options. I don’t know what the duration is in America but here in Holland we have options with a maturity of 5 years!! That’s nice. 🙂
    So you don’t have to be nervous when the stock don’t move in the right direction immediately.

    If you buy deep ITM options i think this is a great alternative/equivalent of buying stocks. There is little time value and the delta is high. So the option act like the stock, but the risk is lower.

    • Mark D Wolfinger 03/15/2011 at 12:42 PM #

      Lies,

      Are LEAPS (up to Jan 2013 right now) really the answer? They may work for you, but they sure don’t work for me.

      I don’t believe it’s fair to make the blanket suggestion that owning long-term options is the right move. It’s okay for some, but not for others. What happens if you buy those options and implied volatility tanks – killing the price of your options?

      Not being nervous immediately: Is that a good idea? I don’t know the answer. I merely ask the question. The investor must get nervous at some point. Without risk management, investing is a game that cannot be won – unless the market returns to it’s bullish ways on a consistent basis.

      Yes DITM options are the best choice among the LEAPS options – at least in my judgment. But they are not cheap and there is time premium to pay. This is not for everyone.

      Lies, if this works for you and gives you an investing method hat sits snugly within the boundaries of your comfort zone, I congratulate you on being so fortunate.

      Regards

  3. Steve B 03/15/2011 at 11:16 AM #

    Mark,

    In your opinion, can finding a way to trade with small capital have a long term negative impact? Meaning, your trading strategy for trading with small amounts of capital won’t always translate to success with that same strategy when you upgrade to more contracts? Or will the strategy produce such small amounts of return that it is no longer the right strategy?

    Does that make sense?

    • Mark D Wolfinger 03/15/2011 at 12:47 PM #

      Hi Steve,

      It makes sense, but I don’t believe it has a negative impact on the educational aspect.

      I believe that learning with small sums is okay from the learning point of view. But for most people, their brokers charge a ‘per ticket’ fee, and that is going to make it almost impossible to have any success when trading one or two-lots. those fees are simply too large for the one-lot trader.

      However, the main reason why small accounts are dangerous is that it is so easy to destroy the account. When learning, and especially when making poor investment decisions (such as gambling by buying options), there is a good chance to lose money on the vast majority of the trades. A small account has no cushion and too many beginners go broke before they have a chance to gain useful experience.

      It’s the risk of ruin that kills the small account holder.

      Thanks

  4. Robert D. 03/15/2011 at 8:20 PM #

    Hi Mark,

    In your reply to Teresa, you say, “A good and conservative method for protecting assets is to use collars. They offer a limited opportunity to earn cash, and that is one reason why I don’t believe they are currently a good choice for you.”

    Would you say the same about credit put spreads, given their positional equivalence?

    Thanks much,
    Robert

    • Mark D Wolfinger 03/15/2011 at 9:45 PM #

      Robert,

      YES and NO.

      Because those two strategies are equivalent, how is that possible? The answer is strike selection and leverage. The collar owner almost always buys an OTM put and sells an OTM call.

      I think of selling put spreads as a strategy with a significant profit potential. Low margin trade, with a good probability of success.
      I think of collars as having a low profit potential. Much higher margin requirement translates into a lower ROI. And the higher strikes means that it loses more often.

      Example: Stock is 58. Collar trader tends to buy 55 puts and sell 60 calls. That’s the equivalent of selling the 55/60 put spread

      The typical spread seller would choose the 50/55 put spread.

      • Robert D. 03/15/2011 at 10:24 PM #

        So the collar loses more often, but the typical collar loss is smaller than the typical spread loss. It seems that over time, in an efficient market, this difference would be a wash.

        Does the greater long-term profitability of the put spread imply that risk can be more effectively managed in the 50/55 case than in the 55/60 case? Or does the collar tend to be less profitable because collar-holders aren’t managing risk as aggressively?

        • Mark D Wolfinger 03/15/2011 at 10:50 PM #

          Robert,

          None of the above.

          It cannot be a wash because the trades are NOT EQUIVALENT. They use different strike prices.

          All collars are not equivalent to all put credit spreads. The strikes and expiration must be identical.

          Comparing the 50/55 put spread with the 55/60 put spread is a reasonable comparison. The latter is far more bullish (more positive delta). Long-term comparisons will depend on whether the market was bullish or bearish.

          Do not ignore that the ‘real’ collar has a much higher margin requirement. It may be equivalent to the 55/60 put spread, but the ROI is much less with the collar. The P/L (measured in cash) are identical, but the ROI is not.

          Regards

  5. Robert D. 03/15/2011 at 10:53 PM #

    A great explanation, as always. Thanks so much.

  6. Bill 08/19/2014 at 11:30 AM #

    Mark,
    I think vertical spreads (bullish put spreads )would be the way to go. Especially on the weeklys. Find a stock or etf that barley moves, and make sure u sell the prifitable side before expiration, and let the loosing side expire… It’s a no brainer for streaming income …OR buy straddles or strangles during earning season, and only buy highly volitile stocks…same as above.. Close out the winning side and let the other expire worthless.. Better chance using these strategies to make $ than many other strategies .

    Bill,

    Orange ct

    See full reply here: https://blog.mdwoptions.com/options_for_rookies/q-weeklys-put-spreads-straddles/