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How Much Do You Need to Start Trading Options?

 

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by Gavin in Blog, implied volatility
December 7, 2017 2 comments

How much capital do you need to start trading options?

This is a question I get asked a lot (along with “are 5%-10% per month returns realistic…).

When starting out in options trading, it is definitely advisable to keep risk small and not start trading a large account straight away.

I was speaking to one trader the other day who had a $20,000 win with his first trade. I explained that this was almost the worst thing that could happen, because he started thinking “this is easy” and “if I can make this much when I don’t know anything, imagine what I can do when I get some more experience.”

Sure enough, this trader blew up his account not long after.

He was taking on too much risk without knowing how to handle it.

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For new traders, it is much better to start with a small account size. Even if you have $200,000 available for trading options, just start with $10,000 and get a feel for how things work. Then, when you’ve been trading for a year or so, SLOWLY build your account from there.

You don’t want to jump from $10,000 to $200,000 overnight.

The psychological aspect of trading a $200k account is much different to a $10k account.

All of a sudden a 1% loss has gone from $100 to $2,000.

So, the big question is how much do you need to get started trading options?

I believe there is no real minimum.

You can start trading with $200.

The experience you gain will be with you for a lifetime, so the earlier you get started the better.

That being said, there are certain strategies that will not be available to you with only a small amount of capital.

Iron condors for example will be hard to trade with less than $5,000.

Also, you need to keep in mind that commissions and fees are going to have a much larger impact on a small account.

Ideally, you want to have around $5,000 to $10,000 at a minimum to start trading options.

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HOW TO TRADE OPTIONS FULL-TIME

To become a full-time options trading requires a big commitment both financially and mentally. As the old saying goes, “It’s the hardest way there is to make easy money”.

Trading is hard, there will be good times and bad times. Will you be able to handle the emotional upheaval the bad times can cause?

The first step to figuring out if you can go full-time, is to figure out how much you need to live off.

If you want to make it as a trader, you need to be prepared to live pretty frugally. We’ve all seen the images of hot shot traders driving Ferraris, but that’s not the reality for 99% of traders out there. Most full-time traders I know live very frugally.

First things first, you should audit your spending behaviour and see if there is anywhere you can cut back without sacrificing your lifestyle.

The next step is to build a track record over a few years and figure out what sort of return you can expect on a consistent basis. It would be good to have this track record through a variety of different market conditions. There are a lot of “bull market geniuses” out there right now, but how will they fare during the next bear market?

Let’s say you’re pretty confident that you can achieve 15% per year. If you can live off $50,000, then you need a capital balance of $333,333.33. If your results indicate you can only achieve a 10% return then you need $500,000 but if you can achieve a 20% return then you only need $250,000.

You can see there is a massive variation in the amount of capital needed depending on your returns.

The best bet is to build that track record and figure out what sort of return YOU can achieve. Every trader is different after all.

Also note, that I haven’t met many traders consistently earning over 20% per year (despite what all those internet ads tell you), and I’ve met A LOT of traders in the last 15 years.

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DEALING WITH LOSING MONTHS

Losing months are never fun for any trader, but they are a double whammy for full-time traders. Not only has your account balance gone down, you’ve also had to withdraw funds to live off.

So your account has taken a double hit, and now you need an above average return next month.

Can you handle that kind of stress?

Having a minimum account size that you’re aiming for is a great idea, but it might be worth waiting until your balance is a little higher than you think you need in order to safely handle those losing months.

Some traders will have 12 months’ worth of expenses set aside (outside their trading account) before making the jump to full-time.

Trading is a tough game, and if you’ve got the added pressure of needing to make a certain return to put food on the table only adds to that stress. Having some emergency funds put aside can help you focus on the business of trading.

ADDITIONAL EXPENSES

One thing a lot of people don’t consider is the additional expenses that can be incurred as a trader. Does your current employer cover your health insurance? Do they pay for your smart phone? Do they provide you with a fast computer? A gym membership?

All these things and more will be your responsibility going forward. If your computer breaks and you don’t know how to fix it, you need to pay a computer guy to fix it for you. Previously your employer would take care of all of this. Same goes for your phone etc.

Be prepared for some additional expenses when you work for yourself.

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CONCLUSION

Hopefully I haven’t stressed you out too much, but the reality is, you need a significant amount of capital before even thinking about becoming a full-time trader.

Those of you who have $50,000 and think you can go full-time, I’m sorry but it’s just not going to happen. Unless you’re a single guy who can live the backpacker lifestyle in Thailand.

But, trading is one of the most rewarding jobs there is. No boss, work from home, travel, the list goes on.

Stick at it, take it step by step and slowly build your account, and you will get there.

Trade Safe!
Gav.

Disclaimer: The information above is for educational purposes only and should not be treated as investment advice. The strategy presented would not be suitable for investors who are not familiar with exchange traded options. Any readers interested in this strategy should do their own research and seek advice from a licensed financial adviser.

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2 Comments
  1. Frank says:

    Great article! I would be happy if I could make $200 – $300 dollars. I have been trading Iron Condors since April. The month of October and November was not good for me. I am debating the worth of trading or whether I simply don’t have the skills. In the meantime I am paper trading, with the hope of figuring this thing out.
    Take Care
    Frank

    1. Gavin says:

      Keep at it Frank, you will get there. October and November were tough months for Condor traders.

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