Most Traders With Small Accounts Trade the Wrong Strategy. Tom Preston Shows the Fix in 9 Minutes.

TSLA

This strategy involves selling a 30 delta put and buying a 25 delta put on Tesla (TSLA) with 45 days to expiration. The backtesting results show a 74% profit rate with an average return of 7.72% per trade. However, the largest individual loss is $10,000, which is significant for smaller accounts. The strategy aims to reduce risk by limiting the potential loss while capturing premium income. The trade is suitable for accounts that can handle the maximum loss, which is $10,000.

short put spread

A short put spread strategy is recommended for traders with smaller accounts who are bullish on a stock like Tesla. This strategy limits potential losses and allows for a more controlled risk profile. The trader sells a higher strike put and buys a lower strike put, collecting a premium while defining the maximum risk. This approach is suitable for traders who want to maintain capital and avoid large single-trade losses, even if the return on capital is lower compared to naked short puts.

Risk Management and Account Size

The difference between trading with a smaller account and a larger account lies in the ability to handle large individual losses. A $10,000 loss is significant for a $5,000 account but manageable for a $500,000 account. This highlights the importance of account size in risk management, as larger accounts can absorb larger losses without significant impact.

Defined Risk Strategies for Small Accounts

Using defined risk strategies like put spreads can be beneficial for small accounts, as they limit potential losses and allow traders to maintain capital even after losing trades. This approach ensures that losses are smaller and more manageable, which is crucial for new traders or those with limited capital. The return on capital may be lower compared to naked short puts, but the reduced risk and higher probability of profit make it a more sustainable strategy for smaller accounts.

What's the real difference between trading an account with a lower amount of capital and an account with a higher amount of capital?

The difference lies in the ability to handle large individual losses. A $10,000 loss is significant for a $5,000 account but manageable for a $500,000 account. This highlights the importance of account size in risk management.

TakeawayLarger accounts can absorb larger losses without significant impact, while smaller accounts may face substantial risks from large individual losses.

What is the difference between a naked short put and a short put spread?

A naked short put involves selling a put without buying a protective put, which exposes the trader to unlimited downside risk. In contrast, a short put spread involves selling a higher strike put and buying a lower strike put, which limits the maximum risk and defines the potential profit and loss. The short put spread is a defined risk strategy, making it more suitable for smaller accounts.

TakeawayThe short put spread is a defined risk strategy that limits potential losses, making it more suitable for smaller accounts compared to the naked short put, which has unlimited risk.