- March 25, 2020
- Posted by: CoachMike
- Categories: Options Trading, Trading Article
‘How big of an account size is necessary to trade options?’
Over the past 20 years I have had the privilege of working with thousands of traders looking to trade in the options markets. This is one of the top questions I get.
The beauty of trading options is they offer tremendous flexibility by providing opportunities to stay active in all market conditions and do so with limited risk. We can do so by using different options strategies like long calls and puts, debit spreads, and credit spreads.
Using a mix of strategies will allow us to react faster to changing market conditions and will also allow us to control our risk better than any other other financial product out there.
Your Options Trading Account Details
To make sure you are able to take full advantage of the features options give us, you need to make sure you are setup with the proper account type and account size.
Let’s walk through some of the basics of opening and funding an options trading account keeping in mind an options beginner may not be ready to trade all types of strategies.
A big component of our options trading approach at NetPicks is keeping the risk small and taking a larger number of small trades. This allows us to spread the risk into many different areas of the markets. The diversification allows us to see more consistency in our trading over time.
- We recommend starting with an account size in the $3500-$5000 range at a minimum. While you can start with less than this, if you do it becomes much harder to control the risk.
- Starting with less than $3500 means one losing trade can have a large impact on your account size and potentially prevent you from taking the next trade.
- We recommend you keep the risk at 2-5% of your account size per trade. This will allow you to stay active without seeing the large drawdowns in your account when a losing trade occurs.
Starting with an account size in the $3500-$5000 range means you are looking to risk between $175-$250 on each trade. Using these risk guidelines will help in determining the number of contracts or spreads that you can take on each trade.
There are 2 main account types that our traders use:
The Margin Account is our preferred type and will give you the most flexibility in how you trade. It will allow you to trade both long calls and puts as well as vertical spreads.
Some traders can get intimidated by the idea of using a Margin Account. The key point to make here is that we are not actually using the margin to trade with. However, it is required to have this account type in order to trade the vertical spreads.
We only teach using risk defined trades at NetPicks so we will always know what our maximum loss is on a trade. This allows us to control the risk even when using the Margin Account.
When using a Margin Account we have to be aware of the Pattern Day trading Rule. This rule states that all accounts under $25,000 can only take 3 day trades in a 5 day period. The account would be prevented from initiating new trades once you go past those 3 trades in a 5 day period.
This account type can be ideal in active markets or for someone looking to take a day trading approach. The advantage of starting with a Cash Account is the low minimum funding requirement. Most brokers require between $50-$100 as the minimum for opening a Cash Account.
- You will be limited to trading long calls and puts only.
- You will not be able to trade vertical spreads in the cash account.
With a Cash Account, you can take as many day trades as you want as long as you have the money available in the account.
If you decide to use one of our preferred brokers (TD Ameritrade or TastyWorks) they allow you to link your accounts.
What this means is you can login to your trading platform and select whether you want to use your Cash Account or Margin Account. You can flip back and forth between the two during the day if needed.
There are many different ways of approaching overall account risk management. We talked earlier about risking between 2-5% of your account on each individual trade. However, we also need to have a rule in place to control overall account risk across all positions.
It’s crucial to have a rule in place for yourself before you ever take a live trade.
I personally use a 50% rule in my own trading. The way this works is I am not willing to have more than 50% of my account at risk at any one time. If I am trading a $100,000 account then I have up to $50,000 of capital to spread across all of my different positions. Please note this $50,000 of capital is typically spread across 20-30 trades.
The 50% rule is what works for me and is a number that I am comfortable with. If you want to be more aggressive or conservative than this you can always adjust the number. It could be a 20% rule or 70% rule.
The number has to be one you are comfortable with and one that you can stay disciplined to.
If I run into a situation where I already have $50,000 of my capital at risk and there is a new trade that I want to take then I would have to close out of part of an existing position to free up the capital to take the new trade and stay below the $50,000 limit I have in place for myself.
Establish Your Rules First
The key to successful trading long term is making sure you are setting yourself up for the best odds of success right off the bat. Many traders will tip toe into the markets without any risk rules in place with the idea that they will circle back to these rules once they start to see some success. Trading is like any other business.
If you don’t take the time to set your business up correctly right off the bat it will be difficult to make it long term.
Take the time to establish these risk rules up front and then commit to following them religiously. Doing so will increase your adds of success.