Options for Beginners: How Much Cash Do You Need?

For investors interested in using options, it’s important to understand the underlying stock as well as the strategy in question.

In this segment from Motley Fool Live that first aired July 9, Motley Fool Canada analyst Jim Gillies, Motley Fool Options advisor Jim Mueller, CFA, and Fool.com editor/analyst Ellen Bowman discuss the portfolio size you’ll need to get started with options.

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Ellen Bowman: We’ve got Patrick from San Jose here on Slido. He says, “How much cash is needed to get started with Motley Fool Options? I’ve been using Rule Breakers and Stock Advisor for the last two years, hoping to start learning Foolish options.” I will let you guys answer, but my memory from when I worked on the service, was we want you to have about $50,000 in your portfolio, and I do not want you to put all of that toward Options.

Jim Mueller: A portfolio size of about 50 grand is about the lower limit that we suggest getting started in investing in options, and you’re going to be doing very few at that size. I’m sorry, doing a lot with options generally requires having a decent-sized portfolio. If you have a portfolio of only 5,000, yeah,
we’ll take your money, we’ll educate on how to do it, but you’re probably not going to be able to do very much about it, so wait. That is not in cash, some option positions can be started with very little cash, some option positions take a fair amount of cash. Like I recall on Starbucks today, will set you back
about $11,000 or so because you have to buy 100 shares to do the covered call, and they’re 116 right now, 117.

Ellen Bowman: There’s a question a little farther down from Rick that Jim Gillies had noticed earlier. “What do you guys think about writing three-month Amazon covered calls generally?” If I remember right, Amazon is not the world’s cheapest stock right now.

Jim Mueller: Thirty-four hundred?

Ellen Bowman: Yeah.

Jim Gillies: Thirty-seven hundred.

Jim Mueller: Thirty-seven? Oh, good.

Ellen Bowman: One covered call is going to represent 100 shares, it’s going to represent-

Jim Mueller: That’s $370,000.

Ellen Bowman: Yeah. What do you guys think about that? [laughs]

Jim Mueller: You want to have a eight figure portfolio to do that.

Ellen Bowman: You would almost have to for any kind of safety, you would have to. Yeah.

Jim Mueller: Because you need a sized position, you don’t want to Amazon to be 90 percent of your portfolio. Maybe you do, but that’s a different issue.

Jim Gillies: One covered call on Amazon today requires about $370,000. That’s great, Rick. If that’s your portfolio size and if that $370,000 represents say, 10 percent or less of your portfolio.

Jim Mueller: You’re still talking 33 million. No, 3.3 million.

Ellen Bowman: So just buy Starbucks, the company outright. [laughs]

Jim Gillies: Well, hang on. 3.3 million? No. 3,700, so 3,700 times 100 is 370,000.

Jim Mueller: No.

Jim Gillies: You’re talking portfolio size, sorry, I recognize.

Jim Mueller: Yeah, portfolio size.

Jim Gillies: Which is great, but the other thing where I would actually caution, Rick, on this one is, remember how we talked about good targets and bad targets for a covered call?

Ellen Bowman: We did.

Jim Gillies: I might suggest Amazon would fall into the not a great target for a covered call.

Ellen Bowman: Is that because its going to shoot the moon or is that because it’s so pricey or?

Jim Gillies: Well, it’s because crack downs on big tech aside, which is a whole other slate of unknowns. I would suggest to you that Amazon, I think, we can call them a winner of the pandemic. That fair? Again, since I’ve done this several times this morning already and I’m out of fresh ideas. To quote David
Gardner, “Winners tend to keep on winning.” I don’t know that I’d want to unnecessarily interrupt compounding of Amazon, even at $1.9 trillion market cap, which is where it is today. As David said, there’s no upside cap.

Jim Mueller: Yeah, because the covered call absolutely stops your capital appreciation at the strike price. You do not get a penny above the strike price.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Ellen Simonson Bowman owns shares of Amazon. Jim Gillies owns shares of Amazon and Starbucks. Jim Mueller, CFA owns shares of Amazon and has the following options: long January 2022 $3,180 calls on Amazon and short January 2022 $3,200 calls on Amazon. The Motley Fool owns shares of and recommends Amazon and Starbucks. The Motley Fool recommends the following options: long January 2022 $1,920 calls on Amazon, short January 2022 $1,940 calls on Amazon, and short July 2021 $120 calls on Starbucks. The Motley Fool has a disclosure policy.

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