Funds Allocation Minimum

The minimum amount that is recommended in trying any trading system is an amount that will at least cover brokerage commissions and subscription fees. It is difficult to have a straightforward answer on this amount when it comes to an uncovered options trading system.

Uncovered options are limited by certain margin requirements, which depend mainly on the current price of the underlying stock and the selected strike price for trading. To better illustrate this, let's consider several trading examples and assuming that a broker uses the following formula to calculate margin:

Margin = (QQQ Price * 0.25 + Options Price - (QQQ Price - Strike)) * 100

In May, 2009, QQQ traded at $34 per share. If we assume that selected QQQ put options are $2 out of the money options (strike = $32) and they cost $1, then the margin, according to the formula above, would be

Margin = (34 * 0.25 + 1 - (34 - 32)) * 100 = $750 per contract

In April, 2010, QQQ traded at $48 per share. By following the same strategy and selecting $2 out of the money options (strike price = $46) which cost $1 (the same as in the example above), we receive a different margin:

Margin = (48 * 0.25 + 1 - (48-46)) * 100 = $1,100 per contract

As you can see, a similar strategy was used to select options for trading in both examples above. However, in 2010, the margin was almost 1.5 times higher than in 2009.

Because QQQ and SPY uncovered put options (that are used in our trading system) are bound by a margin that greatly depends on the current QQQ and SPY price, as well as on selected strike prices, it is difficult to state the exact dollar amount that would be recommended to try our system. It becomes even more difficult when you consider that different brokers may use different margin formula.

As a rule, based on the past performance, we recommend having enough funds to be able to sell at least 7-10 option contracts. The easiest way to grasp the approximate dollar amount equivalent to 5-7 options contracts is to go to a broker's website and use the broker's "Trade Calculator" or "Virtual Trading" (the majority of online brokers have it) and imitate some of our signals. This will help you to understand how uncovered options margin works and will help to determine the approximate amount of funds required to sell short 5-7 options contracts in the current market.