With a little account, you can trade options. Thanks to mobile brokers like Robinhood and We bull, option trading has surged. Options are derivatives that are commonly used to hedge equity positions or execute sophisticated trades, but they are now being employed by retail traders as lottery tickets on their favorite equities. While buying out-of-the-money (OTM) options isn’t a long-term strategy, several traders have profited handsomely from short squeezes in meme stocks like as GameStop (NSDQ: GME) and AMC Theaters (NSDQ: AMC) (NYSE: AMC).
Options are more widely available than ever before, but it doesn’t mean that trading derivatives is right for everyone. Options are complicated, and their rise and fall are influenced by a variety of factors. If you wish to trade options with a tiny account, there are a few rules you should follow to keep your money safe.
What are the possibilities?
An option is a contract that gives the owner the opportunity to buy (or sell) a stock at a predetermined price at some point in the future. The’strike price,’ as it is known, is a predetermined price. The buyer of each contract has the option to acquire 100 shares of stock at the strike price if they want to execute the contract. Options, like the equities that underpin them, are purchased and sold on exchanges. In exchange for the agreement, the person selling the option (known as the writer) receives a premium from the buyer. When the underlying equities rises in value, call options rise in value, while put options rise in value when the stock falls.
Let’s imagine you think Draft Kings Inc. (NYSE: DKNG) shares are overvalued and will fall in value over the following six months. You could short the stock, but it entails borrowing expenses and the risk of losing more than your initial investment if the company rises in value. You could also buy a put option on DKNG stock, which allows you to profit from a drop in the stock’s price while only risking the premium you paid for the put. You might buy the $45 put option that expires on November 19th if DKNG shares are priced at $50 on September 24th. Your option will be “in-the-money” if DKNG shares fall below $45, allowing you to execute it or sell it for a profit.
Option writers get paid up front, but they risk losing more money than they get if the stock goes in the opposite direction. The premium paid for the contract is the only risk for option buyers; assuming DKNG stock never falls below $45, the put in the previous example expires worthless. The premium will be more expensive if the strike price is nearer to the current price. The same goes for alternatives with later expiration dates on the calendar. When the strike price is met, an option is considered to be “in the money.” Options that are “out of the money” have no inherent value and rely on the underlying equity’s strike price being met.
Why Should You Trade Options?
Option trading is popular because it allows traders to handle a 100-share stake with just one derivatives contract. Because of the leverage, there is a lot of volatility, which allows traders to make a lot of money in a short amount of time. The risk, of course, is that the option would expire worthless, resulting in the loss of the entire premium.
Trading options takes far less initial cash, which is why small accounts can quickly grow into large accounts. Options are considered derivatives by many retail traders, who use them to YOLO cash in and shoot for the stars. Options can be used to hedge equity positions, establish income streams, or simply leverage high-probability bets in reality.
Purchasing OTM options is inexpensive and generally risk-free. They’re cheap and offer big rewards, but the vast majority of them will expire with a value of zero. When buying and selling are involved, though, alternatives can become too much to grasp. You’ll need a better understanding of the dynamics that cause option prices to grow and decrease in order to conduct complicated options trades.
Is it possible to trade options on a small account?
Trade options with a small account can make sense in some circumstances, but you must understand the type of trading you’re doing. You won’t be able to hedge your options holdings with the underlying stock, and you won’t be able to afford the premium on already-in-the-money options. This is purchasing out-of-the-money calls or options in the hopes of a significant move – pure speculation, not sound investing.
If you have a high risk tolerance and are willing to invest some money in lottery ticket exchanges, there are a few things to bear in mind:
Options can be sold before they expire, allowing you to benefit from your transaction as soon as it becomes profitable. Set a profit target so you’ll know when to sell and won’t be tempted to stay on for higher profits.
You must have sufficient funds in your account to finance the purchase of 100 shares of stock at the strike price in order to exercise an option. If you don’t have enough liquid cash in your account, your broker may frequently sell your “in the money” option before the expiration date if you don’t have enough liquid cash.
While many brokers offer free stock and ETF trading, commissions on options contracts are common. Make sure you’re aware of all the charges and fees associated with the trade.
It’s difficult to trade illiquid stocks, and it’s even more difficult to trade options based on illiquid underlying stocks. When shares are illiquid, options spreads can be wide, and you may not be able to exit your position at the moment you want. If you want to avoid big spreads or immobile securities, stick to heavily traded companies.
If you’re not sure what you’re doing, don’t write “bare” choices. Option sellers frequently buy the underlying stock in order to collect money now and hedge losses later. If the price rises and the option is exercised, the seller will be able to deliver the shares. Naked options are contracts in which the underlying stock is not owned. The writer keeps the premium, but if the option is exercised, he or she is responsible for purchasing the shares at the strike price. The potential losses for naked option writers are enormous, therefore only utilize this method if you’re a derivatives expert.
Final Thoughts Because options are unpredictable, there are many opportunities to make significant profits. However, volatility cuts both ways, and an option position that gains 25% in one day may be cut in half the next. Buying large quantities of out-of-the-money call options on stocks like GameStop and AMC may have made a few millionaires, but most traders who buy these types of derivatives lose money.
Trading options with a small account can be thrilling because a single big success can frequently compensate for a dozen losses. However, keep in mind that options are frequently part of a bigger portfolio. If you have a low risk tolerance, don’t use them to gambling. Dabbling in options isn’t the worst idea you could think of if you have a modest account and don’t mind losing a few hundred dollars here and there in the search of a 2000 percent trade. Simply put, don’t put more money on the table than you can afford to lose.