How To Option Trade With A Small Account

What options trading strategy do you use if you have a small account? Do you find yourself wondering how to trade options on a small account? If so, this blog post is for you. In the following article, we will discuss some strategies that allow traders with smaller accounts to succeed in options trading.

How To Option Trade With A Small Account
How To Option Trade With A Small Account

What options trading strategy do you use if you have a small account? Do you find yourself wondering how to trade options on a small account? If so, this blog post is for you. In the following article, we will discuss some strategies that allow traders with smaller accounts to succeed in options trading.

Getting started

Before you start trading, it is crucial to understand that there is no shame in having small accounts. Many retail traders take years to become profitable before using larger accounts. Most traders who start with large accounts lose a lot and give up because they cannot stomach future losses. It is essential to remember sometimes more money, more trades, is more problems. Having a small account has less risk and allows traders to get into this by losing with a small account.

The best way to learn is to paper trade with fake money, but unfortunately, it is hard to be emotionally invested with fake money. Managing emotions and controlling risk is a significant part of the game, and that cannot be learned with a paper trade for most people. The bottom line is not to sweat the small account and be grateful for it.

1. Find key support and resistance levels

One of the most important things you can do as an options trader, especially when you have a small account, is to find and trade-off key support and resistance levels. For those who are not familiar with the term, support and resistance levels refer to specific prices at which a security has historically found itself attracted (resistance) or repelled.

These levels are typically areas of high volume where the price has a tendency to fluctuate around, and they tend to be accompanied by changes in volatility.

Example of a trendline

One of the easiest ways to find these levels is by plotting trend lines for support and resistance on a price chart. As you can see in the example below, we have drawn a trend line connecting the higher lows of the stock and identified it as our support line.

The more times security touches this line, the stronger its influence will be. A line that is sloping with support or resistance gives traders a direction to trade with.

The goal is always to play the momentum of the market and enter at the very safest place. Which usually is as close as possible to support or resistance lines within a trend.

example of a trendline

2. Add indicators to your chart for extra confirmation

To further solidify our options strategy, we can add various indicators to improve our technical analysis. Entering more trades at defined areas, shown by many popular indicators, allow for limited risk and excellent trading opportunities. Some of the most popular options include Bollinger Bands (BBs), moving averages, volume profiles, and MACD.

Bollinger Band explained

The BB tool consists of a set of three lines plotted on your price chart: an upper line (the “band”), a middle line (the “mean”), and the lower band. The BBs are used to measure price volatility, which is then plotted against its historical range on your options strategy chart.

bollinger band

Bollinger Band slope

Bollinger bands can also be used to identify trends and consolidation. Whenever the Bollinger Bands are sloping up, we can tell the trend is bullish. Whenever the Bollinger Bands are sloping down, we can tell the trend is bearish.

Bollinger Band bounces

As options traders, we want to be sure our options strategy is on the right side of a trend. We can do this by using Bollinger bands as a visual aid and confirming touches to the top of the bottom bands. These can be opportunities to enter calls at the bottom band touch or puts at the top band touch.

Or possibly taking profit at these moments because any move past the Bollinger Bands likely will not last. This can be seen in the example above where many touches of the top Bollinger Band lead to reversals back to the middle.

Moving averages explained

Moving average options trading strategies are one of the most popularly used options for confirming entries.

These moving averages can be based on anything but it is best to use an indicator that has had a good history of successful trades in your options trading strategy.

Another popular indicator that can be used in options trading is the moving average (MA). There is a variety of MAs, but we will focus on the simple moving average (SMA) as it is the most commonly used.

Moving average slope

Moving average can also be used to identify trends and consolidation. Whenever the Moving average is sloping up, we can tell the trend is bullish. Whenever the Moving average is sloping down, we can tell the trend is bearish.

You can see in the example below that the moving average is sloping up and the stock continues to rise until it falls below the moving average at the top of the trend.moving average slope

Moving average bounces

Moving averages can offer excellent places to enter a trend. Key fast-moving averages allow for possible bounce scenarios.

These fast-moving averages are usually within 5-15 moving offering good short-term bounce or rejection trade opportunities. The slower moving averages around 50-200 offer good long-term bounce or rejection trade opportunities.

You can see in the example above that the moving average offers many good entry points for the trader to enter into the trend. These bounces are the safer entry places traders target because they offer the best risk to reward.

Volume profiles explained

Volume profiles show how much volume is accumulated at different prices points of a security during a certain period of time. This data can help options traders find support and resistance levels by looking at the highest peaks.

These peaks on the volume profile show where the most trading volume has occurred. These are likely places where price gravitates to and bounces from higher or lower.

In the example below, you can see there are three major zones where the peak of the profile, price will likely travel higher or lower to the next zone once it is done going through the auction process in its current volume profile zone.volume profiles

3. Find tight patterns after large moves

The key to finding a stock about to move is to make sure there has been a recent move either making new highs or new lows for the day, week, or month.

There is a handful of patterns that will allow traders to enter this momentum before the next big move. These consolidation setups are often perfect for small accounts and short-term options.

Example of triangle setup

A triangle formation on the chart is the perfect opportunity to enter a strong trend for the next move. The stock market typically moves in a very large way and then consolidates before the next large move.

These ebbs and flows of momentum are easy to spot in patterns like this and are exactly what we look for when trying to play momentum.

These patterns are perfect for small accounts because they leave little time to wait for the next move and allow traders to see movement relatively quickly.

The goal, as stated previously, is to enter as the safest possible place or wait for a confirmed breakout. In the example below, this would occur at the triangle support level where all the past bounces occur.

A breakout would be when the stock breaks above the white resistance line. The closer and closer price action trends to the apex the higher and higher chance we have of getting the breakout. The apex is the ultimate entry point if you are certain of the direction to follow.

triangle setup

Example of flags

Flags are another great opportunity to enter in a momentum play before the breakout or after. This is very similar to the example above with the triangle but a different kind of consolidation.

You can see in the example below, there was a very large move that resulted in consolidation where the stock stays in a tight range. But once stock breaks above the channel sideways the next leg higher occurred which ended up being very similar in size to the previous run. The key to flag, like the triangle, is just a matter of entering at confirmed support or waiting for a confirmed breakout.

The triangle is a preferred setup because price action gets tighter and tighter. The tight price action has a higher chance of leading to a larger break. While the channel can be drawn out and harder to enter and exit from.

flags in options trading

4. Be mindful of small accounts size related to position size

Finally, options traders should be aware of the risks involved with the size of their small account related to position sizing when they enter a trade.

Account Size: One important factor for successful options trading is to have an options trading strategy that fits your specific account size.

Position Sizing: Another important factor is to always trade a position size that is relative to the account size.

For example, if your account's buying power is $500, a trading position size of $100 per trade will have more risk. Instead, using $20 or $25 per trade offers defined risk.

This will allow you to stay in the market longer and you a solid foundation to learn.

And what you want to really know is your small account budget, it's going to be around 5% to even 15% of the account size. If you're feeling risky the higher percentage the riskier the trade could be for your whole account.

That's where I stick whenever I'm options trading. But remember: these are just general guidelines and each options trader should tailor their approach based.

Example of an option strike price within budget

In the example below, you might be bullish on KO and looking for calls. If you had an original investment of $500 in your small account, that would mean you could afford $25-75 per option. The larger the account value the more a trader could afford per trade.

But in the beginning traders with a small account can receive the same exact percent returns that a $1,000 option might give. Just cause options may be cheap, does NOT mean they cannot move just as much.

That would be within the 1-15% value of the small account based on the trader's risk tolerance. Any more and it would be incredibly risky.

Looking at the expiration date 20 days out we can see the options at the money range from $78 to $136. These would be outside the budget so the next step would be to look for a shorter time frame.

This would only make sense if you really had conviction the move would be coming soon and would be 100% related to if you charted properly.

option strike price within budget

Picking the correct strike price

Picking the strike price correctly can be a make or break for the trader. Going too far with otm options contracts can lead to aggressive time decay and minimal gains from price movement.

Going too far in the money can lead to little leverage and wasted capital tied up in a trade. The key is to compare the time decay versus the delta.

As long as theta is 50% of the delta, the trade will likely be able to pay for time decay from price movement. With a decay too large it will be almost impossible to profit in a trade, an easy way to lose money, and can lead the option to expire worthless.

In the example below, we can see that theta and delta are equal which would make this contract a poor choice and be considered too far out-of-the-money.

picking the right strike price

Using shorter expiration dates

Moving to an expiration date of 10 days out we can see the price of the options decrease a lot. The at the money cost of the options is around $11 to $89.

using shorter expiration dates

Optimal option contract amount

This means for the $58.5 strike we could likely afford 3 options at our max budget. This allows the trader to scale out of a winning trade slowly at key profit levels.

Selling your whole position in a single trade is very foolish if the trade continues to run 500-1000%. The only solution to missing out on huge gains is being able to have a couple of contracts initially.

The goal is to have one contract run 100% which would allow the trader to sell one contract and get back their initial capital and then leave one contract to run. This would be called the free ride contract as it is already paid for from the previously sold contracts.

Finding options within your budget

In the example above, KO options 1-2 weeks till expiration were within the small account budget and even allowed the trader to grab multiple. The stock price was around 10% of the small account value, so one would assume you could just use any $50 stocks and you could find options to fit your budget. That would be a wrong assumption. Options are highly related to volatility so if volatility is high the option prices are going to be much higher.

The underlying stock, KO, has an implied volatility of 11% which is extremely low compared to most stocks on the market. If we look at another $50 stock with a higher IV, we can see the option price at the money is actually $123 for the $60 strike. This means we won't have enough capital to respect our position size requirements based on our buying power. This is a magnitude of 6 times more expensive than the KO at the money options. This is mainly due to the increased volatility which reads 49% for this particular CHWY option.

Which happens to be about 5-6 times more than the IV(implied volatility) of KO. This means for highly volatile options to fit the budget we need to be looking for a cheap stock to be around $10-15 if we were using a $500 small account.

When you start trading options for a small account it is important to not waste time with stocks too expensive or implied volatility too high. Just focusing on stocks within our budget will save time and help traders not overextend themselves in any one trade.

finding options in your budget

5. Measuring risk to reward

Options traders should also be mindful of their risk-to-reward ratio. This is the amount of profit you expect to make on a trade, divided by the amount of risk you are taking on that trade.

For example, if you are risking $100 to make $200, your risk-to-reward ratio would be 0.50 ($200 / $100). While options trading strategies do not always have to be perfectly balanced in risk-to-reward, you should aim for options trades with a ratio of at least one ($200/$100 = 0.50)

The more options traders are willing to risk on an options trading strategy, the higher their options trading strategy risk-to-reward ratio should be.

Conversely, the fewer options traders are willing to risk on a particular options trading strategy, the lower their options trading strategy risk-to-reward ratio should be.

How to predict possible profit

From the example above, where we chose the $58.5 strike for KO. If we were to calculate what it would take to make 100% we would have to look at the lower strike prices and see where the price of the option jumps up by 100%.

The very next option below has a price of $53, which is exactly 100% more than the option of our choice. So in order to make that 100%, the stock would have to move the difference of the $58.5 and $58 strike, which is $0.50.

predicting possible profit

Is the move possible?

Knowing what amount makes you 100%, it is then important to go to the chart and see if it is even possible. To know if it is possible to move a certain amount I always ask myself, is there any resistance higher than $0.50 from the current price? Is there past price action, moving averages, Bollinger bands before the $0.50 higher?

When we pull up the chart, we can see that the very next level of resistance is actually $0.60 away. This would validate the setup and trade opportunity to check all the boxes needed.

The only thing left to do now is to enter, follow the plan, and respect the stop loss. But we absolutely need to analyze a setup, the risk to reward, check the option chain, and review the chart before entering any trades.

This process will put traders in better positions to succeed instead of struggling from the beginning. The last part can always be the hardest, so be sure to control your emotions and follow your plan. Good or bad, you will always learn something important at the end of the day.

will my trade work out?

Can it get stopped out early?

Getting stopped out of a trade can be very annoying especially when the trade ends up hitting our profit zones. The only way to predict if a trade will get stopped out early is to look at the option chain and see how much of a move will cause a 50% loss, or whatever percentage the trader is using for their risk to reward. In the example, here we will use 50%.

getting stopped out of a trade early

In the example previously we calculated that a 50 cent move in the stock would produce a 100% return based on looking at the strike price differences. We can use this same trick for analyzing the stock loss potential. If we look at the 59 strike price we can see the price of that option is 0.11, this expected value is roughly 50-60% lower than the price of the 58.5 strike option (the one we chose). So again, based on the strike prices, if the stock makes a 40-50 cent move would stop us out of this trade.

After knowing the amount, the trade would go against us in order to stop us out. We then check out the chart to see if there is room to run 40-50 cents against us. It is important to look for key support lines or moving averages.

If those key levels are 40-50 cents away there is a high probability we could travel there, get stopped out, and then see this trade become profitable later in the week.

Looking at the chart below, we can see the red line being our stop loss level which is 50 cents lower. We can also see a supportive trendline at 58.00 for KO which tells us that there is a high chance we support that trendline before going lower.

This doesn't promise we won't get stopped but gives us a solid level before our stop loss that we will likely hold. Plays that have much support before the stop loss gets hit are some of the better plays to enter.

Example of a personal choice

Personally based on my past performance, I am always looking to target a 100% option swing trade because options can lose value drop in price really quickly. I have seen an options trade overnight lose 20-30% and then could be a winning trade later in the day.

Because of this implied volatility in the options market I have moved my stop loss to most trades to 50% down. Following the initial risk to reward above 0.5, that means my profit target zones would have to be a minimum of 100% gains.

Personally, I have also learned from experience that once an option drops 50% in value with less than 15 days till expiration, the chance of it ever making a profit is extremely small. This chance of profit gets even smaller with options are 7 days till expiration and down 50%.

This is just a personal preference but I have learned from my mistakes and know how important it is to control risk. I always tell our traders to never let their losses define them. We are always going to have a bad day here and there but it is important to make them smaller than the good days. Make sure the bad days are never colossal days.

6. Shorter expiration date options trading have higher reward and risk

When options traders are looking at different options strategies, they will often find that shorter-term expiration dates have a higher reward potential but also come with a higher risk.

This is because the options trader has less time to be wrong in their trade and still make a profit. Conversely, longer-term expiration dates offer a lower reward potential than shorter options but come with a lower risk because the options trader has more time to make money.

Example of a short term option risk to reward

In the example above with KO, we can see that a short-term option 7 days till expiration had a possible 100% return with a 50 cent move. If we were to add 3 more weeks till expiration a 50 cent move would only make a 40-50% return. About half as much return and costing twice as much.

For small accounts, this can be a waste of money. If traders are able to respect stop losses and find great momentum plays there is no use in paying more than you need to on a trade. If you truly get the move instantly the risk to reward is greatly in your favor with the shorter-term options.

It should be understood that a vast majority of short-term options move the quickest against you and have a huge overnight decay. These two facts can blow up many small accounts if position size is disregarded.

short term option risk to reward

7. Important of a stop loss

A stop loss is an order that options traders use to limit their losses on certain options strategies.

For example, if you are long a call option and the stock starts to go against you, your stop loss would be triggered and you would then sell the option to limit your losses.

A stop-loss order is designed to limit your losses on a particular options trading strategy, not necessarily protect you from all downside risk.

Keep in mind that a stop-loss order is not a guaranteed way to limit your options trading risk. For example, if you are long a call option and the stock gaps up on your stop-loss order, then there is nothing that can be done to limit your losses in this situation.

Risk to reward chart

Below is a chart we made for our trading group to visually show how important it is to have a good risk-reward and respect losers. As you can see in the example below, cutting a losing trade at 80% down means your winning trades will need to be over 160% to equal the 1:2 risk to reward ratio. The smaller our losers the smaller winners we need as well. Cutting a losing trade around 10% down means taking profit at 20-30% could lead to long-term profitability.

calculating risk to reward chart

Example of a stop loss

Setting a stop loss is possible on most platforms and can help traders honor a loss instead of relying on doing it themselves. Sometimes the emotions take over and losses are never respected because of it. In the example below, you can see I am setting my stop loss right at 50% for the limit price.

This is the max I will ever risk in the trade and in order to make sure this executes, I set my stop price a bit higher. A stop-limit will trigger the order to be entered and as long as the market doesn't gap lower quickly, this order should be exited at $0.12. If for whatever reason the price of the option opened at $0.05, the order would never go through since it gapped right under our limit price.

long call

8. Other option strategies

This blog won't go completely in-depth on these very complex small account strategies. But there are ways to utilize options that control even more risk and allow almost any option to be affordable to small accounts.

This is done through iron condors, debit spreads, credit spreads (which are referred to as vertical spreads). This is the act of selling an option and buying them at the same exact time. This allows traders to take advantage of time decay as well as develop neutral positions for stocks that may not move.

Those who have accounts with big trades or investments will look to utilize covered calls for passive income or to protect those positions through selling calls and cash-secured puts. Unfortunately, type of strategy is not easy for small accounts as it requires a lot more money and a larger account.

Small account options strategy takeaways

In this blog post, we’ve shared our best small account options trading strategy that can help you utilize options without having large accounts. This is just one example of how to plan, execute, and analyze a trade to fit any account size. You don't need to work for wall street to learn options, we want to help educate the world on their power one person at a time.

Of course, we recommend consulting a professional before making any decisions about investing in this volatile market because we are not financial advisors and this is not investment advice!

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