Options trading is both highly leveraged and highly lucrative. It's very easy to consistently generate abnormally high returns on individual trades (20%, 50%, 70%, etc), but that is just for one trade. It is easy over-leverage your account so we have to put in place some sort of barrier to prevent over-allocation.
In today's video, we want to talk about maximum capital usage. In options trading, we know it’s both highly leveraged and highly lucrative, and it’s very easy to consistently generate abnormally high returns on individual trades.
We've shown before in many video tutorials and with our live trades that you can generate 20%, 50%, 70% return on your capital. But remember that these are just single individual trades.
With the ability to easily over-leverage your account, trying to shoot for the homerun, we have to put in place some barrier to prevent over-allocation and leave room for expansion in the margin and additional trades and protect you from yourself. That’s what we try to do here.
We advocate keeping cash on hand of around 40% to 50% of your portfolio at all times. This is the war-chest as my beautiful wife calls it these days.
It’s that amount of money that you have to have on hand in case everything else goes wrong so that you still have the ability to open up the doors tomorrow and trade.
Even if you still have 50% to 40% of your account in cash at all times, that doesn't mean that you can go and be a rodeo cowboy trading options and allocate too much to one particular trade. We still suggest the sliding scale of 1% to 5% that we published inside of our membership area.
If you're new to Option Alpha, you can download that PDF guide with allocation guidelines at optionalpha.com. Again, 40% to 50% of your account at all times in cash.
Basically, what this means is that the optimal kind of split for us as far as maximum capital usage is we want to be using about 60% of our account at the most here to generate income with our trades.
That doesn't mean that we’re going to take 60% and throw it into one trade or two trades. We’re still going to split that up into maybe 60 trades over the course of a couple of months because they overlap, the different expiration periods, but we’ll try to keep as much capital as we can in our account in cash just in reserve.
Remember, our goal is to generate an abnormal return or Alpha on a small portion of our account. Try not to get too comfortable trading your full account balance.
Really, even if you have a smaller account, I know you probably have to allocate just a little bit more to start to generate income because of the account size, but even then, you still don’t want to get too comfortable trading your account, all of your account balance.
You want to have some of that money left over just in case anything happens or really, just in case you need the cash to do something else.
As always, I hope you guys enjoy these videos. If you have any questions or comments, please add them right below on the lesson page. Until next time, happy trading!