Now that you have your new household organized and have set up a budget for your regular expenses, you might find you have some money left and would like to start trading and earning some profits from your shoestring trading budget. The availability of low-cost options contracts and the significant leverage available from trading options makes this type of security a good choice to start trading on a limited budget. Because you will be starting with a small amount of trading capital, it is important to have a well-thought-out trading strategy and not take risks that are too large with your trading capital.
Select a brokerage with which to open an options trading account. Compare several brokerages that specialize in options trading using the following criteria: Minimum account balance -- you need a brokerage that allows trading with a small amount of money; options trading commissions -- to start you will be trading one or two contracts, so calculate the costs for each brokerage to trade one options contract; options trading education and tools -- brokerages that specialize in options trading offer significant educational resources that give a better chance to trade successfully. The availability of a practice trading account allows you to practice your strategies without using real money.
Study the information available from the brokerage or the Options Industry Council about bull and bear spread trades. These strategies can be implemented using either call or put options, and can be used to profit from a stock price expected to go up or one that is forecast to decline. These strategies are also referred to as vertical spreads. The basic spread strategy involves buying an option that will profit if the underlying stock moves in the expected direction and simultaneously selling a slightly different, lower-cost option to lower the cost of the trade. Vertical spreads are one of the lowest cost ways to trade and maintain an attractive profit potential on a trade.
Pick a few stocks or exchange traded funds to follow and watch for trading opportunities. If you follow just a few trading candidates you will become familiar with how the share prices move up and down and will be able to enter your option spread trades when the profit potential is best.
Use a practice -- no real money -- option trading account to practice your option spread strategies. The practice account allows you to learn how the brokerage's trading system works and to learn if the option trades you are picking will be profitable. Do not start trading with real money until you are consistently profitable on the practice account.
Start trading options with real money in small increments. You have a small budget with which to work, so only risk a small amount -- an amount you are willing to lose -- with your initial trades. For example, if you have $500 in your trading account, only risk $100 on any trade and have no more than two trades open at a time. As your account grows, you can increase the size of your trades or the number of open trades. Also, work to decrease the percentage of capital at risk with each trade.
- Option contracts cost $100 times the price quoted on an options price screen. For example, if you are buying an option priced at $4.00 and selling one quoted at $2.50, the total cost of the trade would be $400 minus $250, or $150, plus broker commissions.
- With a small trading account, it is better to select trades with higher potential of success and lower potential profit. You want to make a lot of small wins and have a small number of losses.
- With a small trading account, it is possible to lose your entire account value in just a few trades. Always understand how much money you have at risk with any options trade. Shooting for a big win or trying too hard to recover losses are paths to wiping out your trading account even faster.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.