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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