Picture this scenario. You have done your homework, you studied the basics of investing and you even passed all the quizzes from the Investment Education Series. You spot an industry that’s growing rapidly, and you’re able to identify the best company within it that has an undervalued stock. It’s now time to invest! Time to put all that research and study into action and claim victory! But there’s one problem, you only have $100 to invest. Don’t worry, there’s still hope. In fact, there are many ways to solve this problem, but I will show you one clever way of investing with only one hundred dollars.
The two instruments that I’ll discuss below can answer our problem of how to start investing with $100. They are sound approaches and can be safely used by most first-time investors.
1. Dividend Reinvestment Plans (DRPs) and Direct Stock Purchase Plans (DSPs) allow you to bypass brokers (and their commissions) by buying stock directly from the companies or their agents. Most major corporations offer these types of stock plans for free, or with fees low enough to make it worthwhile to invest as little as $20 or $30 at a time. Drips are great for investors starting with small amounts and can make frequent purchases (dollar-cost averaging) to build their stock holdings over time. Some companies allow you to set up an automatic payment plan so the investment process becomes really easy.
2. Exchange Traded Funds (ETFs). You can also start building your portfolio with exchange-traded funds, or ETFs. These instruments trade like stocks and mimic the behavior of different types of assets (stocks, bonds, real estate or commodities). They typically track an index, such as the S & P 500 (SSO), Nasdaq 100 (QLD), or Russell 2000 Index ($RUT.X). Since ETFs trade on major exchanges, investors can do the same types of trades that they can do with stocks. For example, they can be sold short, trade with a limit order, use a stop-loss order, buy on margin, and invest as much or as little money as they wish because there is no minimum investment requirement.
My Preferred Approach: Options
Don’t get scared now! This instrument is not as “complicated” as you may think. It just really depends on how you use them. I will teach you how to use it in its simplest sense, just bear with me for a while and put your learning hat on. A stock option is a contract that gives the buyer the right, but not the obligation, to buy or sell a specific stock at a specific price on or before a certain date. There are two types of options; one for giving the buyer the right to buy (known as calls), and the other giving the buyer the right to sell (known as puts). The specific price at which an underlying stock can be purchased or sold, by virtue of an option, is called the strike price. The date until which an option can be used is called the expiry date. There are so many options plays available to investors, but for our intents and purpose, we will be focusing on buying calls. That is, we are betting that the price of the stock will go up. Just like stocks, options trading involve risk, especially if you don’t know what you are doing.
How to Do It
I am assuming here that you are done with your due diligence. Sorry, but stock tips emailed to you by a stranger does not count as due diligence. It must be through a solid analysis of a company’s fundamentals and valuations before you can qualify for that. Now let’s move on. The plan is to basically buy a long-term call option on an undervalued stock. By the time the stock reaches its target price, the option price would have appreciated by at least a few times of what you paid for. Remember though, that an option’s price becomes zero when the expiry date arrives, so you must choose a value that can be reasonably reached before your options expire.
Here are the steps:
1. Login to your brokerage account. If you don’t have one, here is a good place to start. I personally think Ally Invest (formerly know as TradeKing) is the best choice for trading stocks and options. They’ve got great customer service, a great trading platform, great learning materials, and most of all great commission prices! So go open an account with that $100 now.
Note. Ally Invest is US only. So if you live outside US, I recommend TradeStation. It’s an awesome broker with cheap prices and good customer support.
2. Once logged in, go to their trading page. Type the ticker symbol of the company you’re interested in buying and search for its options chain. (Get help from your broker’s helpdesk if you cannot find this on your own).
3. Once the options chain page shows up, select the furthest expiration date that you can find. I think the furthest expiration dates would be around two years going forward. Once you select the furthest dated options, look at the middle column where the strike price is indicated. Look up the strike price that is nearest your target price or the price you think the company is worth per share of stock (remember that current prices should be below your target strike price). On the left side of the strike price column, you would normally find the calls. The puts are usually found on the right side of the strike price column.
4. Buy to open the contract/s in the call row that corresponds to the target strike price. Option prices or premiums, are quoted for one share of stock. Since one contract lets you have buying or selling rights of 100 shares, the quoted price should be multiplied by 100 to arrive at the contract price. For example, if a contract is quoted at $0.35, multiply it by 100 to give you $35 per contract. At that price, you can buy as much as three contracts with your $100. If the strike or target price of the contract that you are buying is above the current price, then you are buying what is called an out of the money option.
5. Sell to close your contracts when the underlying stock price hits your strike price. At this point, the contracts that you bought for a few cents would now be priced more than a dollar. Out of the money contracts bought for $0.25 or $0.35 can now be sold for more than a dollar. Definitely double your money. On the downside, if your analysis doesn’t pan out, your contracts may expire worthless and you lose your original $100. Okay, time to breathe. Review the process and make sure to get this right. I repeat, this is how I’d invest if I only had $100 to invest. With this strategy, you may win at least double your $100 and you may lose all of it. You can always choose to invest with DRPs and ETFs if you find this too risky. But remember Warren Buffet’s saying, that “risk comes from not knowing what you’re doing”.
As a final note, investing with a minimal amount requires you to be careful with your brokerage costs. A high quality but great priced broker can help you preserve your capital, so choose one wisely. Again, I think Ally Invest is the best for options trading whether you are a novice or a pro. TradeStation is the best online brokerage for Traders outside US.