Options Strategies for Small Accounts

If you have a small trading account, well then this video is for you. It teaches you an option strategy that can help small accounts to make a nice healthy return without taking exorbitant risk. I'm Mike Bellafiore and we're a long-standing proprietary trading firm located in New York City since 2005 and now Miami as well and proud to develop numerous consistently profitable traders. Watch, take notes and learn from our prop firm so you can grow your trading account. Hi, I'm Seth Freiberg and I'm the head trader of SMB Capital's Options Trading Desk here in Manhattan. And we're in contact with traders from all over the world who have the impression that you need this huge amount of capital in your account to trade option strategies, which is frustrating to folks who haven't accumulated much capital to trade with. But that's not actually true. In fact, there are lots of very attractive options trading strategies that don't require much capital at all. And that's what we're going to be covering in today's video. Now, before we get into the options strategy that we'll be teaching you in today's video, if you're absolutely brand new to options trading and you don't know much about how options work, we've put together a video for you to understand options basics. And if you click the video appearing on your screen right now, it will lay the groundwork for you to understand the options strategy that we'll be sharing with you in this video. Then when you're finished, you can come back and watch the rest of the video. As we were saying earlier, people may have heard in passing that you need tons of capital to trade option strategies. And that may well be because they've only been exposed to the strategies that require the most capital, the strategies that I call the capital hogs, because they do, in fact, require lots of capital and may not be accessible to traders that have limitations on how much capital they can put into their account. So, for example, let's take a look at the capital requirements of a strategy known as the iron condor, which... some of you may have heard of. And so, for example, let's say that you went back to October 1st of last year when the Russell 2000 index, the well-known index of small cap stocks, was trading at $22,1151. And you pulled up an options chain that expired at the end of October, the October 31 options chain, expiring 30 days later. And he finds a strike price about 100 points above the index trading price, which is the 2310 call option. and he sells one of those calls for 1830. And at the same time, he heads down to the options chain, 100 points to the downside, to the 2110 put, and he sells one of those for 2065. Then simultaneously, he goes ahead and buys the call 50 points higher at 2360 for 935, and he also buys the put 50 points lower at 2064, 1275. Now, when he does this, selling a call and put closer to the index trading price and buying a call and put farther away from the trading price in the same options chain, when he does this, he is entering into what options traders refer to as an iron condor. And so let's first focus on what has just happened from a cash flow perspective when we enter an iron condor. And so starting with the 2310 call we sold, we got a price of 1830 for that call. But remember, Each index option pays off at a rate of $100 per point that the index closes beyond the call strike price on the day it expires. So we multiply that price by 100. And so the total cash income from selling that call is $1,830, as you can see from the calculation. And using that same kind of calculation, you can see that we collected $20.65 from selling the $21.10 put. And then, of course, we had to pay for the... protective call at $2,360 and the protective put at $2,060. And so those costs are deducted from our cash flow. And so when you net them all down, you could see that we would have had positive cash flow of $1,685 after entering this trade that morning. And that would have immediately, by the way, increased the cash balance in your account by that amount. Okay, so now let's focus on how much capital this trade requires. And so to do that, we want to remind you of how buying and selling index options works. You see, if you sell an index call, then you are the one obligated to pay $100 per point for every point that the index closes above the strike price of the call on the day that that call expires. But if you buy an index call option, you're the one who is collecting the cash, $100 per point above the call strike price on expiration day. And so in the downside, if you sell a put, then you are the one paying off $100 per point that the index closes below the put strike price and when you buy a put you're the one collecting the cash if the index closes below that put strike price. So let's see what bearing this explanation has on the trade that we just did. Let's say that the index closed at 2380 on the day this trade expires. Well in that case the index closed 70 points above the short call strike price of 2310. So we'd have to pay out seven thousand dollars for that short call. But since it also closed 20 points above the long call at 2360, then we collect $2,000 for that one, meaning that we would pay out net $5,000 for the call side of the trade. And in fact, that's the maximum loss that we could possibly experience. Why? Well, think about it. Once the index gets past 2360, no matter how much higher it goes, the 2360 call gets activated. and it starts paying off $100 per point. And so the payoff from the 2360 call is rising at the exact same pace as the 2310 call, which basically negates any further loss to you once you get past 2360. And so at this point, you're maxed out. The loss can't get any worse than $5,000, which is why we call that long call the protective call, because it puts a limit on the size. of the loss from the call side. And the exact same thing is true on the put side. Once the index closes any lower than 2060, then that 2060 long put effectively stops the loss from growing because the long put will start paying off at the exact same pace as the short put up at 2110, stopping the loss again at $5,000. And the reason that we're going over all of this is to bring us back to the question of how much capital you'd need to execute this iron condor trade. You see, as we mentioned, an iron condor is a short and long call above the index price and a short and long put below the index price. So you can actually only have a loss on one side, either the call side or the put side, but not both. Why? Well, if the index closes above the short call, then obviously the puts are going to expire below the index price. And so those are untouched and just expire worthless. And the same is true for the put side. If the index closes below the short put, then both calls expire worthless for the exact same reason. They're untouched. And so because of that, the loss can never get past $5,000 on an iron condor because if the index closes below the long put or above the long call, situations where the trade would pay out at $5,000, then obviously the other side pays out nothing and just expires worthless. In other words, And IGDX can't close in two places, below the short put and above the short call. It can only, in the worst case, be one of those outcomes. And so we've proven to you that even though the call and put sides of the iron condor are both exposed to loss, only one side can actually experience a loss. And in this case, that maximum loss would be $5,000. But there's one more thing we need to keep in mind, and that is that we collected, remember, $1,685 when we first entered the trade. And so in reality, the worst loss actually is $3,315 because we could, in the worst case, pay out $5,000, but we received initially $1,685. So our net loss would actually be, at worst, $3,315. And so when you first enter this trade, your broker will require you to have at least $3,350 in your account. because your broker is going to impose a $5,000 margin reserve on your account, which reduces the buying power of your account by $5,000. Because you collected that $1,685, the cash effectively increased your buying power. And so the net effect is that you're going to need $3,315 to get into this trade. Your broker is going to give you a credit against the margin. In other words, because it recognizes your cash balance just increased. So now you can see why we're saying... that your iron condor required capital in this case of $3,315. So let's now move to October 31st, the day that the trade expires. And as you can see, the index closed down that day, closing at $2,196.65. And so since the options have all expired, we can now assign a final value to each option. And as you can see, that's going to be pretty easy to do because both calls expired above where the index closed. And both... puts expired below where the index closed. In other words, the index closed between all four options, resulting in both of the calls. and both of the puts expiring worthless. And so what that means is that because none of the options had to pay off anything, then we just get to keep the cash that we first collected, that $1,685 as our trade profit, which, as you can see, results in a return against required capital of 50.83%. Okay, so that's a pretty good return, except for one thing. Suppose you only have $1,000 in your account. Well, your broker would have required more than that. And so that would have obviously precluded you from putting the trade on in the first place. And so I've got a solution for that. And that is to change option strategies away from the capital hog like the iron condor and instead implement a different kind of a trade, a trade known as the iron butterfly. And let's see how this changes things because it's pretty intriguing. You see, if on that same day, instead of entering into the iron condor on October 1, we had pulled up that same options chain, but we implemented a different trade. Suppose that at the exact moment we entered that iron condor, if instead of entering that iron condor on that same day, we went to the options closest to where the index was trading at that time, which if you remember was $22.1157, and we went ahead and sold both the $22.10 call, which was trading for $57.95, and the $22.10 put, which was trading for $51. And then for protection, to put a cap on the loss potential of the trade, just like we did for the iron condor, we buy a 2260 call 50 points away, just like before. And we also buy a 2160 put, again, 50 points away, just like with the iron condor. In other words, the separation between our short and long options remained at 50 points. But this time, instead of selling calls and puts. 100 points away from the index price, as in the iron condor, we sold the calls and puts right at the index price. Well, when we do this, selling a call and a put at the same price and buying a call above the short call and a long put below the short put, when we do that, we are entering into what options traders refer to as an iron butterfly. And while it's got a lot of similarities to iron condors, the big difference is... that the short call and the short put are both at the money at the same strike. And because of that, the amount of cash you are bringing in selling those calls and puts is way larger because, of course, if a call or a put strike price are right at the index price, then one of them is going to make a payoff because the market will either go up or down. And so the ones selling the calls and the puts have got to load a lot of price into those options to cover their obligations to pay them off. And so it should be no surprise to you that we get paid much more handsomely for the iron butterfly than we do for the iron condor. Because the short options we're selling are bringing in so much more, as you can see from the cash flow here. And while the longs are actually closer and more expensive, the shorts are just so crazy filled with premium that we end up with a ton more premium. In this case, $4,205. versus the $1,685 we received selling the iron condor. But here's the part you may not realize, but it's hugely important as far as your account size is concerned, and that is the effect this bonanza of cash is going to have on your capital requirement. You see the payout situation of this iron butterfly, because the shorts are again 50 points away from the longs, is the exact same payout situation of the iron condor. The maximum. that can be paid out is $5,000 on either the call side or the put side. For example, if the index closed at $2,300, then the 2210 calls would pay out $9,000, and the 2260 calls would pay us $4,000, resulting in a maximum payout of $5,000, regardless of the outcome. Just like with the Iron Condor example. No matter how far the index rallies, we'd still have a maximum loss of $5,000 for the same reason. Once the long call kicks in, it negates any further losses caused by the short call dollar for dollar. Exact same thing. And the same, of course, for the put side. And so now that we've proven to you that the iron butterfly and the iron condor have the exact same maximum payout, then the implications of that are huge. Why? Because with so much more premium, look what happens to the capital requirement. The maximum loss is exactly the same, but the premium reduction is huge, meaning that the capital requirement is tiny. Only 25% of the capital requirement of the iron condors you could see, only $795. And so when we move to the end of the day, this time with the index closing at the same price, the result is a whole lot different. You see, starting with the original cash, with the index closing below the short call of $2210 by more than 13 points, both of the calls expire worthless, as you'd expect, because both the short and long calls are located. above where the index closed. But then we get to the short 2210 put, which the index pierced by 13.35 points, as you can see from the calculation. And so that one pays out $1,335. And then finally, the long put at 2060 expires below the index price. And so it also goes out worthless. So we end up with much more cash than we pay out, resulting in a profit of $2,870. way more profit than we made on the iron condor with way less capital resulting in a huge 361% win on the capital that we risked and more importantly the capital that your broker will require for you to make this trade in the first place. And so what I'd like you to take away from today's video is that you absolutely can trade option strategies with a smaller account if you understand how to structure the trades to utilize much less capital and therefore provide yourself with an opportunity. opportunity to make much more profit and return on your risk capital. Professional options traders know many techniques for controlling the capital requirements of trades, and now you have some idea of how they accomplish that. Now, if you'd like to learn three more options strategies that our pro traders use, including the unique options trick that allows you to make money while you wait to buy stocks or ETFs at the price you want, and the options income strategy that allows you to make consistent money whether the market goes up or down or sideways and how to make money on a stock or index trade even if you're wrong on the direction then click the link that's appearing right now at the top right hand corner of your screen that will open up the free workshop registration page in a new window so don't worry you won't lose this video or you can register directly for free at optionsclass.com.

And we're in contact with traders from all over the world who have the impression that you need this huge amount of capital in your account to trade option strategies, which is frustrating to folks who haven't accumulated much capital to trade with. But that's not actually true. In fact, there are lots of very attractive options trading strategies that don't require much capital at all.

And that's what we're going to be covering in today's video. Now, before we get into the options strategy that we'll be teaching you in today's video, if you're absolutely brand new to options trading and you don't know much about how options work, we've put together a video for you to understand options basics. And if you click the video appearing on your screen right now, it will lay the groundwork for you to understand the options strategy that we'll be sharing with you in this video. Then when you're finished, you can come back and watch the rest of the video.

As we were saying earlier, people may have heard in passing that you need tons of capital to trade option strategies. And that may well be because they've only been exposed to the strategies that require the most capital, the strategies that I call the capital hogs, because they do, in fact, require lots of capital and may not be accessible to traders that have limitations on how much capital they can put into their account. So, for example, let's take a look at the capital requirements of a strategy known as the iron condor, which...

some of you may have heard of. And so, for example, let's say that you went back to October 1st of last year when the Russell 2000 index, the well-known index of small cap stocks, was trading at $22,1151. And you pulled up an options chain that expired at the end of October, the October 31 options chain, expiring 30 days later.

And he finds a strike price about 100 points above the index trading price, which is the 2310 call option. and he sells one of those calls for 1830. And at the same time, he heads down to the options chain, 100 points to the downside, to the 2110 put, and he sells one of those for 2065. Then simultaneously, he goes ahead and buys the call 50 points higher at 2360 for 935, and he also buys the put 50 points lower at 2064, 1275. Now, when he does this, selling a call and put closer to the index trading price and buying a call and put farther away from the trading price in the same options chain, when he does this, he is entering into what options traders refer to as an iron condor. And so let's first focus on what has just happened from a cash flow perspective when we enter an iron condor. And so starting with the 2310 call we sold, we got a price of 1830 for that call.

But remember, Each index option pays off at a rate of $100 per point that the index closes beyond the call strike price on the day it expires. So we multiply that price by 100. And so the total cash income from selling that call is $1,830, as you can see from the calculation. And using that same kind of calculation, you can see that we collected $20.65 from selling the $21.10 put. And then, of course, we had to pay for the... protective call at $2,360 and the protective put at $2,060.

And so those costs are deducted from our cash flow. And so when you net them all down, you could see that we would have had positive cash flow of $1,685 after entering this trade that morning. And that would have immediately, by the way, increased the cash balance in your account by that amount. Okay, so now let's focus on how much capital this trade requires.

And so to do that, we want to remind you of how buying and selling index options works. You see, if you sell an index call, then you are the one obligated to pay $100 per point for every point that the index closes above the strike price of the call on the day that that call expires. But if you buy an index call option, you're the one who is collecting the cash, $100 per point above the call strike price on expiration day. And so in the downside, if you sell a put, then you are the one paying off $100 per point that the index closes below the put strike price and when you buy a put you're the one collecting the cash if the index closes below that put strike price.

So let's see what bearing this explanation has on the trade that we just did. Let's say that the index closed at 2380 on the day this trade expires. Well in that case the index closed 70 points above the short call strike price of 2310. So we'd have to pay out seven thousand dollars for that short call. But since it also closed 20 points above the long call at 2360, then we collect $2,000 for that one, meaning that we would pay out net $5,000 for the call side of the trade.

And in fact, that's the maximum loss that we could possibly experience. Why? Well, think about it. Once the index gets past 2360, no matter how much higher it goes, the 2360 call gets activated.

and it starts paying off $100 per point. And so the payoff from the 2360 call is rising at the exact same pace as the 2310 call, which basically negates any further loss to you once you get past 2360. And so at this point, you're maxed out. The loss can't get any worse than $5,000, which is why we call that long call the protective call, because it puts a limit on the size. of the loss from the call side.

And the exact same thing is true on the put side. Once the index closes any lower than 2060, then that 2060 long put effectively stops the loss from growing because the long put will start paying off at the exact same pace as the short put up at 2110, stopping the loss again at $5,000. And the reason that we're going over all of this is to bring us back to the question of how much capital you'd need to execute this iron condor trade.

You see, as we mentioned, an iron condor is a short and long call above the index price and a short and long put below the index price. So you can actually only have a loss on one side, either the call side or the put side, but not both. Why?

Well, if the index closes above the short call, then obviously the puts are going to expire below the index price. And so those are untouched and just expire worthless. And the same is true for the put side.

If the index closes below the short put, then both calls expire worthless for the exact same reason. They're untouched. And so because of that, the loss can never get past $5,000 on an iron condor because if the index closes below the long put or above the long call, situations where the trade would pay out at $5,000, then obviously the other side pays out nothing and just expires worthless. In other words, And IGDX can't close in two places, below the short put and above the short call.

It can only, in the worst case, be one of those outcomes. And so we've proven to you that even though the call and put sides of the iron condor are both exposed to loss, only one side can actually experience a loss. And in this case, that maximum loss would be $5,000.

But there's one more thing we need to keep in mind, and that is that we collected, remember, $1,685 when we first entered the trade. And so in reality, the worst loss actually is $3,315 because we could, in the worst case, pay out $5,000, but we received initially $1,685. So our net loss would actually be, at worst, $3,315. And so when you first enter this trade, your broker will require you to have at least $3,350 in your account.

because your broker is going to impose a $5,000 margin reserve on your account, which reduces the buying power of your account by $5,000. Because you collected that $1,685, the cash effectively increased your buying power. And so the net effect is that you're going to need $3,315 to get into this trade. Your broker is going to give you a credit against the margin.

In other words, because it recognizes your cash balance just increased. So now you can see why we're saying... that your iron condor required capital in this case of $3,315. So let's now move to October 31st, the day that the trade expires. And as you can see, the index closed down that day, closing at $2,196.65.

And so since the options have all expired, we can now assign a final value to each option. And as you can see, that's going to be pretty easy to do because both calls expired above where the index closed. And both... puts expired below where the index closed. In other words, the index closed between all four options, resulting in both of the calls.

and both of the puts expiring worthless. And so what that means is that because none of the options had to pay off anything, then we just get to keep the cash that we first collected, that $1,685 as our trade profit, which, as you can see, results in a return against required capital of 50.83%. Okay, so that's a pretty good return, except for one thing.

Suppose you only have $1,000 in your account. Well, your broker would have required more than that. And so that would have obviously precluded you from putting the trade on in the first place.

And so I've got a solution for that. And that is to change option strategies away from the capital hog like the iron condor and instead implement a different kind of a trade, a trade known as the iron butterfly. And let's see how this changes things because it's pretty intriguing. You see, if on that same day, instead of entering into the iron condor on October 1, we had pulled up that same options chain, but we implemented a different trade. Suppose that at the exact moment we entered that iron condor, if instead of entering that iron condor on that same day, we went to the options closest to where the index was trading at that time, which if you remember was $22.1157, and we went ahead and sold both the $22.10 call, which was trading for $57.95, and the $22.10 put, which was trading for $51.

And then for protection, to put a cap on the loss potential of the trade, just like we did for the iron condor, we buy a 2260 call 50 points away, just like before. And we also buy a 2160 put, again, 50 points away, just like with the iron condor. In other words, the separation between our short and long options remained at 50 points.

But this time, instead of selling calls and puts. 100 points away from the index price, as in the iron condor, we sold the calls and puts right at the index price. Well, when we do this, selling a call and a put at the same price and buying a call above the short call and a long put below the short put, when we do that, we are entering into what options traders refer to as an iron butterfly. And while it's got a lot of similarities to iron condors, the big difference is... that the short call and the short put are both at the money at the same strike.

And because of that, the amount of cash you are bringing in selling those calls and puts is way larger because, of course, if a call or a put strike price are right at the index price, then one of them is going to make a payoff because the market will either go up or down. And so the ones selling the calls and the puts have got to load a lot of price into those options to cover their obligations to pay them off. And so it should be no surprise to you that we get paid much more handsomely for the iron butterfly than we do for the iron condor.

Because the short options we're selling are bringing in so much more, as you can see from the cash flow here. And while the longs are actually closer and more expensive, the shorts are just so crazy filled with premium that we end up with a ton more premium. In this case, $4,205.

versus the $1,685 we received selling the iron condor. But here's the part you may not realize, but it's hugely important as far as your account size is concerned, and that is the effect this bonanza of cash is going to have on your capital requirement. You see the payout situation of this iron butterfly, because the shorts are again 50 points away from the longs, is the exact same payout situation of the iron condor.

The maximum. that can be paid out is $5,000 on either the call side or the put side. For example, if the index closed at $2,300, then the 2210 calls would pay out $9,000, and the 2260 calls would pay us $4,000, resulting in a maximum payout of $5,000, regardless of the outcome. Just like with the Iron Condor example. No matter how far the index rallies, we'd still have a maximum loss of $5,000 for the same reason.

Once the long call kicks in, it negates any further losses caused by the short call dollar for dollar. Exact same thing. And the same, of course, for the put side. And so now that we've proven to you that the iron butterfly and the iron condor have the exact same maximum payout, then the implications of that are huge. Why?

Because with so much more premium, look what happens to the capital requirement. The maximum loss is exactly the same, but the premium reduction is huge, meaning that the capital requirement is tiny. Only 25% of the capital requirement of the iron condors you could see, only $795.

And so when we move to the end of the day, this time with the index closing at the same price, the result is a whole lot different. You see, starting with the original cash, with the index closing below the short call of $2210 by more than 13 points, both of the calls expire worthless, as you'd expect, because both the short and long calls are located. above where the index closed. But then we get to the short 2210 put, which the index pierced by 13.35 points, as you can see from the calculation.

And so that one pays out $1,335. And then finally, the long put at 2060 expires below the index price. And so it also goes out worthless.

So we end up with much more cash than we pay out, resulting in a profit of $2,870. way more profit than we made on the iron condor with way less capital resulting in a huge 361% win on the capital that we risked and more importantly the capital that your broker will require for you to make this trade in the first place. And so what I'd like you to take away from today's video is that you absolutely can trade option strategies with a smaller account if you understand how to structure the trades to utilize much less capital and therefore provide yourself with an opportunity.

opportunity to make much more profit and return on your risk capital. Professional options traders know many techniques for controlling the capital requirements of trades, and now you have some idea of how they accomplish that. Now, if you'd like to learn three more options strategies that our pro traders use, including the unique options trick that allows you to make money while you wait to buy stocks or ETFs at the price you want, and the options income strategy that allows you to make consistent money whether the market goes up or down or sideways and how to make money on a stock or index trade even if you're wrong on the direction then click the link that's appearing right now at the top right hand corner of your screen that will open up the free workshop registration page in a new window so don't worry you won't lose this video or you can register directly for free at optionsclass.com.

Transcript for:Options Strategies for Small Accounts

Transcript for:
Options Strategies for Small Accounts