How much money do I need to start trading?
Investopedia.
The step towards becoming an active trader is a big one, because the world of active trading is quite different from that of casual investing. It is important to understand the implications of making the switch, including increased commissions, which could be wipe out your gains before you really begin.
Commissions.
Commissions most likely are the largest cost you will take on as an active trader. Other expenses, such as software, Internet, and training costs, could be high, too, but often they are dwarfed by the cost of commissions. A trader sometimes will make over 100 transactions per month and commissions can vary widely depending on the broker you are working with. It is important not only to shop around for the best software, execution speeds, and customer service, but also to look around for commission costs that are most favorable to you.
Things to Look For.
Although there is no hard and fast rule for how much you should have in your account to start trading, many brokerages will set this amount for you. For example, a brokerage may say that you need a minimum of $3,000 to open a margin account, the type of account you would need to make short sale trades or to purchase or sell options.
For a good start, be sure to look out for account minimums at the brokerages you investigate. This number usually is set for a reason because it is in the brokerage's best interest to keep you trading for as long as possible to ensure that they continue to collect commissions. These minimums often are put into place to reduce the risk of you burning up your entire account in just a few trades, or even worse, getting a margin call. In the case of the latter, you would have to deposit more funds into your account in order to keep your current position open.
This question was answered by Ayton MacEachern.
Notman, Derek.
Great question! Simple answer, it depends. What are your goals with the money? Where do you want it to be in the future? How will trading fit into the rest of your financial planning?
There are a variety of online brokers, like Scottrade for example, that let you set up an account with very little money. I would encourage you to speak with a CFP professional to get some perspective and objective advice, perhaps it will help you crystallize how you should set up and fund your trading account. Feel free to check out my website to learn more.
Call Option Trading Example.
How To Make Money Trading Call Options.
Example of Call Options Trading:
Trading call options is so much more profitable than just trading stocks, and it's a lot easier than most people think, so let's look at a simple call option trading example.
Call Option Trading Example:
Suppose YHOO is at $40 and you think its price is going to go up to $50 in the next few weeks. One way to profit from this expectation is to buy 100 shares of YHOO stock at $40 and sell it in a few weeks when it goes to $50. This would cost $4,000 today and when you sold the 100 shares of stock in a few weeks you would receive $5,000 for a $1,000 profit and a 25% return.
While a 25% return is a fantastic return on any stock trade, keep reading and find out how trading call options on YHOO could give a 400% return on a similar investment!
How to Turn $4,000 into $20,000:
With call option trading, extraordinary returns are possible when you know for sure that a stock price will move a lot in a short period of time. (For an example, see the $100K Options Challenge)
Let's start by trading one call option contract for 100 shares of Yahoo! (YHOO) with a strike price of $40 which expires in two months.
To make things easy to understand, let's assume that this call option was priced at $2.00 per share, which would cost $200 per contract since each option contract covers 100 shares. So when you see the price of an option is $2.00, you need to think $200 per contract. Trading or buying one call option on YHOO now gives you the right, but not the obligation, to buy 100 shares of YHOO at $40 per share anytime between now and the 3rd Friday in the expiration month.
When YHOO goes to $50, our call option to buy YHOO at a strike price of $40 will be priced at least $10 or $1,000 per contract. Why $10 you ask? Because you have the right to buy the shares at $40 when everyone else in the world has to pay the market price of $50, so that right has to be worth $10! This option is said to be "in-the-money" $10 or it has an "intrinsic value" of $10.
Call Option Payoff Diagram.
So when trading the YHOO $40 call, we paid $200 for the contract and sold it at $1,000 for a $800 profit on a $200 investment--that's a 400% return.
In the example of buying the 100 shares of YHOO we had $4,000 to spend, so what would have happened if we spent that $4,000 on buying more than one YHOO call option instead of buying the 100 shares of YHOO stock? We could have bought 20 contracts ($4,000/$200=20 call option contracts) and we would have sold them for $20,000 for a $16,000 profit.
Call Options Trading Tip: In the U. S., most equity and index option contracts expire on the 3rd Friday of the month, but this is starting to change as the exchanges are allowing options that expire every week for the most popular stocks and indices.
Call Options Trading Tip: Also, note that in the U. S. most call options are known as American Style options . This means that you can exercise them at any time prior to the expiration date. In contrast, European style call options only allow you to exercise the call option on the expiration date!
Call and Put Option Trading Tip: Finally, note from the graph below that the main advantage that call options have over put options is that the profit potential is unlimited! If the stock goes up to $1,000 per share then these YHOO $40 call options would be in the money $960! This contrasts to a put option in the most that a stock price can go down is to $0. So the most that a put option can ever be in the money is the value of the strike price.
What happens to the call options if YHOO doesn't go up to $50 and only goes to $45?
If the price of YHOO rises above $40 by the expiration date, to say $45, then your call options are still "in-the-money" by $5 and you can exercise your option and buy 100 shares of YHOO at $40 and immediately sell them at the market price of $45 for a $3 profit per share. Of course, you don't have to sell it immediately-if you want to own the shares of YHOO then you don't have to sell them. Since all option contracts cover 100 shares, your real profit on that one call option contract is actually $300 ($5 x 100 shares - $200 cost). Still not too shabby, eh?
What happens to the call options if YHOO doesn't go up to $50 and just stays around $40?
Now if YHOO stays basically the same and hovers around $40 for the next few weeks, then the option will be "at-the-money" and will eventually expire worthless. If YHOO stays at $40 then the $40 call option is worthless because no one would pay any money for the option if you could just buy the YHOO stock at $40 in the open market.
In this instance, you would have lost only the $200 that you paid for the one option.
What happens to the call options if YHOO doesn't go up to $50 and falls to $35?
Now on the other hand, if the market price of YHOO is $35, then you have no reason to exercise your call option and buy 100 shares at $40 share for an immediate $5 loss per share. That's where your call option comes in handy since you do not have the obligation to buy these shares at that price - you simply do nothing, and let the option expire worthless. When this happens, your options are considered "out-of-the-money" and you have lost the $200 that you paid for your call option.
Important Tip - Notice that you no matter how far the price of the stock falls, you can never lose more than the cost of your initial investment. That is why the line in the call option payoff diagram above is flat if the closing price is at or below the strike price.
Also note that call options that are set to expire in 1 year or more in the future are called LEAPs and can be a more cost effective way to investing in your favorite stocks.
Always remember that in order for you to buy this YHOO October 40 call option, there has to be someone that is willing to sell you that call option. People buy stocks and call options believing their market price will increase, while sellers believe (just as strongly) that the price will decline. One of you will be right and the other will be wrong. You can be either a buyer or seller of call options. The seller has received a "premium" in the form of the initial option cost the buyer paid ($2 per share or $200 per contract in our example), earning some compensation for selling you the right to "call" the stock away from him if the stock price closes above the strike price. We will return to this topic in a bit.
The second thing you must remember is that a "call option" gives you the right to buy a stock at a certain price by a certain date; and a "put option" gives you the right to sell a stock at a certain price by a certain date. You can remember the difference easily by thinking a "call option" allows you to call the stock away from someone, and a "put option" allows you to put the stock (sell it) to someone.
Here are the top 10 option concepts you should understand before making your first real trade:
Options Resources and Links.
Options trade on the Chicago Board of Options Exchange and the prices are reported by the Option Pricing Reporting Authority (OPRA):
A Simple Guide To Making Money With Options.
Over the past few decades, we've seen many advances in how the stock market functions. Today, exchanges and brokerage houses exist almost entirely online, and everyone is competing for microseconds of speed.
As a quick example, let's say IBM is currently trading at $100 per share. Now, let's say an investor purchases one call option contract on IBM with a $100 strike price at a premium of $2.
The call option gives the buyer the right to purchase shares of IBM at $100 per share. In this scenario, the buyer could use the option to purchase those shares at $100, then immediately sell those same shares in the open market for $105. Because of this, the option will sell for $5 on the expiration date.
Using the same analysis as shown above, the call option will now be worth $1 (or $100 per contract). Since the investor spent $200 to purchase the option in the first place, he or she will show a net loss on this trade of $100.
If IBM ends up at or below $100 on the option's expiration date, then the contract will expire "out of the money," meaning it will now be worthless. In this scenario, the option buyer will lose 100% of his or her money (in this case, the full $200 that he or she spent for the contract).
Profit Amplifier Closed Trades.
Aside from a few road bumps, our path to success has been very profitable. In fact, my readers and I have made an average return of 14.5% on our trades so far, and our average holding period stands at just 40 days -- that's good for a 132% annualized return.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of NASDAQ, Inc.
How Much Money Should You Invest In Options Trading?
January 22, 2012.
For many people who are beginning options trading, they make the mistake of investing too much of their money in the new business.
And since I get this question a lot from new traders I wanted to take the time to cover it in more detail in today's post.
A key part of a financial education is understanding the basics of risk management with respect to your entire portfolio; specifically how your income capabilities and your risk tolerance level should determine the allocation to options.
1st: The Importance of an Emergency Fund.
Before you even think about trading options (or any other investing for that matter), it is essential that you have set aside an adequate emergency fund to prepare yourself for the unexpected events.
Although many experts may debate the actual amount of money needed in such a fund, the consensus is that you should be able to support yourself for 3 to 6 months from your emergency fund.
Since an emergency fund is designed to protect yourself in case of an emergency, that cash should be easily accessible in a highly-liquid savings account or money market fund. Check out our post on the top 8 places to park your cash for ideas.
Under no circumstances should you think about investing these funds in options; given the risk management characteristics of emergency funds, this cash should only be placed in accounts that have very little risk attached to them.
And never make any excuses as to why you "need" to take money out of it. It shouldn't be used for a new car purchase or a new iPad.
Where To Find Money to Invest in Options.
Once your emergency fund is fully funded, you can start to think about the cash that is available to you for options trading. If you have any additional savings that are not a part of your emergency fund, this cash could conceivably be used as part of your allocation towards options trading.
In addition, I would make it a point to include or at least allocate any future income that you earn from your current job to grow your portfolio. Budget out your monthly expenses and include a line item for the "trading fund."
At least that's why my wife and I do each month. We allocate 5% of her pay to the "trading fund" and, of course, all my income just stays in there except what we pull out for my personal salary to myself.
Regardless of how you allocation the key here is to find something you can consistently put towards your future. If that means skipping a Starbuck's Latte each week then say goodbye to those delicious Pumpkin Spice Lattes!
Start The FREE Course on "Options Expiration” Today: Whether you are a completely new trader or an experienced trader, you'll still need to master the basics. The goal of this section is to help lay the groundwork for your education with some simple, yet important lessons surrounding options. Click here to view all 12 lessons ?
So What's The Magic Number Kirk?
Back to that question everyone asks, " How much should I invest? " I would say at least $5,000.
Honestly, this is just a guidepost and not a requirement but here's how I got there. . .
First you don't need a million dollars (or anything close to it) to be successful. We've already debunked that myth in this popular podcast episode looking at two traders in a case study.
But that said to start with no money or very little money makes it extremely hard to get some consistency in positions. With less than $5,000 you might only end up trading 1 or 2 positions per month which is frankly not enough to generate income to cover commissions.
Lastly, at least $5,000 puts enough skin in the game that you take this seriously. There is something to be said about watching your money closely, and I firmly believe that if you have a bigger chunk of money invested you are going to be more invested in learning how to trade options smarter.
5 Extra Things to Consider.
Although such a broad-based education in personal finance could take a lifetime to learn, a few key lessons that I have learned along the way and wanted to share are as follows when it comes to allocation of funds:
Always have an adequate emergency fund of at least 3-6 months. Do not invest in anything you don't understand. Hence why we offer free education. Keep all of your positions sizes small for a reason - because you make more money. Diversify your investments among asset classes, strategies, and timelines. Never invest money you can't afford to lose (beginners pay attention here!) If you worry about risk management first, the profits will take care of themselves.
Options trading is an inherently risky financial activity that should only be pursued by those people who have developed effective risk management and asset allocation strategies.
However, if you are willing to obtain the education and perform the hard work necessary to make money at it, options trading can be a very rewarding and profitable.
About The Author.
Kirk Du Plessis.
Kirk founded Option Alpha in early 2007 and currently serves as the Head Trader. Formerly an Investment Banker in the Mergers and Acquisitions Group for Deutsche Bank in New York and REIT Analyst for BB&T Capital Markets in Washington D. C., he’s a Full-time Options Trader and Real Estate Investor.
He’s been interviewed on dozens of investing websites/podcasts and he’s been seen in Barron’s Magazine, SmartMoney, and various other financial publications. Kirk currently lives in Pennsylvania (USA) with his beautiful wife and two daughters.
I think the best way to learn is by having “skin in the game” If I were mentoring a new trader I would say take 1/3 of what you want to invest and use it after you have worked out some in the virtual trader for 1-3 months. Let them know they will probably lose most of it, the worst thing you can do is get in too soon. Small gains will give the new trader the illusion you know what youre doing but ultimately you will lose more than you gain.
Jake, Yup at some point really money makes you trade different than paper money.
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