What Are the Best Option Strategies for Small Accounts?

If you have a larger account, keep reading because I'm going to make the case that the best strategies for small accounts are also the best strategies for larger accounts.

If you're new to options, and you don't have large amounts of capital, where do you start?

*Source: AMC Networks*

In Season 2 of the AMC television series, Preacher, Tulip spends time at a New Orleans bar called The Hurt Locker collecting cash for being shot in the chest while wearing a bullet proof vest.

Now, her motivation isn't really about the money.

But I still think it's an apt metaphor for the trades and strategies that beginning option traders with smaller accounts all too often find themselves in.

Safety First, Returns Second

The more capital you have, the more opportunities you'll also have, but whether you have a few thousand to invest or a few million, the focus should be on safety first, returns second.

That doesn't mean you can't get great returns trading conservatively.

In fact, inside the Leveraged Investing Club, our objective is to maximize our returns within the context of never losing money.

Seriously.

Now, obviously, we don't have a 100% track record of winning trades.

Even legendary NBA free throw god Rick Barry missed a free throw from time to time.

But we really do expect to walk away from every trade with more money than we started with.

It's our Heads We Win, Tails Mr. Market Loses approach.

When we're right about a trade, we make easy, no drama, lucrative returns - or Heads We Win.

And when we're wrong about a trade, because we're only working with a Strategy that's flexible, forgiving, and, at the end of the day, eminently repairable, we're almost always able to fix anything that Mr. Market throws at us - or Tails Mr. Market Loses.

What kind of returns are we talking about?

Inside the Leveraged Investing Club, we target 15-25% annualized returns on all of our new Sleep at Night Strategy trades (with an initial projected duration in the 3 week to 45 day time frame).

And this is on real cash-secured capital, not artificially low capital bases (e.g. credit spreads or margin usage) that some shady types like to calculate from when hyping their services.

The exception are the small, conservative bear call spreads we began incorporating in 2018 to round things out and make the Sleep at Night High Yield Option Income Strategy truly all weather.

The annualized returns on these are skewed by the minimal capital requirements - which I'm transparent about.

But if calculated on a fully cash secured basis (i.e. the strike price of the short call times 100 shares times the total number of contracts involved) the annualized ROI for these spreads would generally be in line with that of our short put trades.

When we're right, we'll get those returns (or better), but even when we're wrong, we almost always still end up with decent to good annualized returns when all is said and done.

(As in something more in the 5-15% annualized range, although in the vast majority of times, the returns still end up being double digit annualized.)

Here's an article that explains the four possible outcomes of our trades and how we're consistently able to book profits at the end of the day on just about all of them.

(And here's another article on why I love using the annualized metric.)

The Myth of Great Returns Requiring High Risk

It's true that if you want a shot at astronomical returns, you're going to have take big risks, but at the end of the day, that's gambling, not trading, and certainly not investing.

What I've come to believe is that being a high risk trader doesn't mean you've got a chance of doing better than most other people.

It means that it's just a matter of time before you lose a large part of your capital - however big or small that may be.

The problem with just starting out with a smaller capital base is that it's easy to be tempted to trade riskier strategies - and often without you even realizing it - simply because those strategies have smaller capital requirements.

Like most debit and credit spreads.

The cardinal sin - and biggest drawback - of most option strategies is the requirement that you be right or else you're going to lose money, and maybe not a small amount either.

The leverage of options is a double-edged sword.

But options are also inherently flexible risk management instruments.

The problem is that most strategies use that flexibility not to reduce or control risk (as much as their practitioners claim otherwise) but to creatively build even more leverage into a trade.

Credit spreads such as a bull put spread, for instance, can be constructed to either reduce risk or to leverage and amplify potential returns. But you have to choose because they can't do both at the same time.

The Safest Option Strategies

The safest option trading strategies, in my view, are the ones that best simulate conservative or sensible (value) investing - basically covered calls or selling cash-secured puts.

I'm not talking about generic covered calls or generic naked puts, or simply selling calls or puts arbitrarily.

I'm talking about customizing these strategies as a way to build upon and enhance core, proven value investing principles.

And it also helps immensely that you're on the selling side of the ledger (in terms of time value) vs. that of the buying side.

At the end of the day, that's the biggest factor that enables us to routinely take a losing trade and repair it back into a winning trade.

Again, the important thing to keep in mind as part of the foundation of your option trading education, if you're just starting out (or if you're just starting over if your results to date are unsatisfactory) is that options are basically leverage and risk control instruments.

What that means is that they magnify any trading or investing approach.

So if your approach is already speculative and aggressive, your potential gains (and losses) are magnified.

(Or as I say, you can blow up your account that much quicker and that much more spectacularly).

But options can also be customized to enhance smart, value-oriented investing - meaning that you can enhance your returns while reducing your risk even more.

The problem is that it's going to be challenging to implement an investing-oriented option trading program when all you have to work with is, say, $2500.

Selling puts, covered calls, and even our new small, conservative bear call spreads can be seen as a form of synthetic value investing.

But if you're undercapitalized, especially when it comes to managing and repairing a trade if necessary, what should be a safe and conservative strategy becomes a risky and speculative one.

In fact, I would say that having $5K-$10K available is the minimum amount of capital that you could effectively begin working with.

What Should You Do if You Have Less Than That?

I know that may not be particularly welcome news when you're trying to start out with less than that, but if you currently find yourself in that situation, I firmly believe that your best course of action is two-fold:

>> Find ways to build up your capital base - on the personal finance side of things (e.g. more savings, cutting personal expenses, etc.) rather than spending energy searching for high risk strategies that you can employ with smaller amounts of capital.

>> Immerse yourself in value investing and value oriented (short vs. long) option trading resources now so that when you do have enough capital to get going, you'll already have a solid foundation in place.

I'm biased, of course, but the Daily Options Tips and Insights Newsletter and the Great Option Trading Strategies website are terrific - and free - resources that have a lot to offer anyone who's new (or not that new) to the process.

Follow @LeveragedInvest