How much capital is required to trade is a question which crosses just about every trader’s mind somewhere along the way. It certainly comes up in questions on trading forum sites frequently. I actually got a fairly specific version of the minimum funding questions yesterday by and emailer.
How much is needed to start trading options? What things should I be considering before going ahead?
There are a few general things which come in to play here:
- How many positions will you have open at a time?
- What is the price level of the underlying market?
- Are you trading in, out, or at the money options?
- Are you doing outright long/short positions,Â or spreads?
Obviously, the fewer positions you have open the less capital you need. Likewise, if you’re trading options on lower priced underlying markets the price of the options will tend to be lower. For example, an option on a $100 stock is going to be markedly more expensive than one on a $10 stock.
Similarly, there’s a difference in cost, and thus capital needs, depending on whethere you are trading options that are in-the-money (ITM), out-of-the money (OTM), or at-the-money (ATM). ITM options will be the most expensive and OTMs will be the cheapest, and the further away from ATM you get the greater the price differentials.
Finally, if you are doing outright long or short positions your capital needs will probably be greater than if you are spread trading. This isn’t a guaranteed thing, though, as in some cases spread trades can require just as much capital as goingÂ straight long or short. It depends on the strategy in question.
Consider the strategy as well
Beyond those basics, there is the need to look as your method of trading and what it means to things like exposure and potential drawdowns. More frequent trading probably, but not necessarily, means a higher capital requirement. That likely depends mostly on how many overlapping positions you’d have, but also takes into consideration transaction costs. They can really chew up an overly small account.
What kind of losses you may take on individual trades makes a difference as well. If you are figuring that you will lose all or most of the money you put into a trade (or potentially more if you’re shorting) then you’ll need more capital than if you normally would only take fractional losses on the options when trades go against you.
You also need to consider your risk of ruin, in a manner of speaking. Basically, that’s a look at the potential drawdowns you could suffer. You have to make sure you’ll never lose enough to keep you from being able to trade any more. That means having enough staring capital to make sure any drawdown that may come about will not cause too much trouble.
If you’re just getting started in options, stick to one position at a time and one contract in size, and focus on lower priced underlying stocks you could probably begin with $1000 and be assured of at least a few trades to get your feet wet. Once you’re beyond that stage and are set to really make a go at trading options with a decent chance of success you’ll probably want to be working with something
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About the Author
John Forman, author of this blog, has traded for more than 20 years, is a professional market analyst, and authored The Essentials of Trading. He is an active participant in trading forums, consults for trading related businesses, as published literally dozens of trading articles, and has been quoted in a number of books and in the media.
** See John’s full bio.