Doc’s note: My colleague Jeff Clark is one of the best traders I know. Jeff regularly shows his readers how to reduce risk while generating steady income… even if the market has a huge move.
For example, Jeff made an incredible 10 times his money the Friday afternoon before Black Monday in ’87. And back during the volatility of 2008, he logged more than 10 different 100% gains… and helped a lot of Stansberry readers make a fortune. (In fact, Jeff won “MVP” at Stansberry that year.)
In today’s essay, Jeff debunks a common misconception about trading options… And he shows how to use them to reduce your risk…
Most people say options trading is risky.
Novice traders often don’t take the time to learn the right way to use options. They jump right in, thinking, “I got this.” They gamble, blow up their accounts, and then walk away penniless and swearing off options forever.
Even experienced traders sometimes get caught up in the allure of fast gains. They over-leverage their positions – take a bigger position size than they should – and then take a hit. All the options traders I (Jeff Clark) know, including myself, have blown up their accounts at least once.
But it’s not the option that’s risky. It’s the strategy. When used the right way, options are far less risky than trading stocks.
Let me explain…
Most people use options the wrong way. Most people use options to increase leverage… to get more “bang for their buck.” In other words, most people use options to increase risk.
That’s wrong. That’s the exact opposite of what options were designed for.
The options market was created so investors could reduce risk. Options allow investors to hedge their positions… and to risk much less money than they would if they bought a stock outright.
Let’s say you want to buy stock in Company X. It trades for $10 a share. You could put up $1,000 to buy 100 shares… But you can control the same amount of stock with one option contract. You can buy a contract for, let’s say, $50… and leave the other $950 in your account.
If Company X’s stock goes up, you’ll make money. If the stock goes down, the most you’ll ever lose is that $50. That’s a 100% loss… But it’s a lot less than potentially losing 20% or more of the $1,000 you would risk if you bought the stock.
This is a simple example. And it’s the simplicity that proves my point. Options allow you to risk much less and profit just as much as you would by buying stocks.
But that benefit disappears if you over-leverage the trade and take on a larger position with options than you would otherwise take with stocks.
That’s the biggest mistake most novice options traders make. Instead of replacing a 100-share purchase with one call option (an option that gives you the right – but not the obligation – to buy or sell a particular stock at an agreed-upon price at a set time in the future), they take the entire amount they would have allocated to the stock and buy a much larger position with the options.
Rather than buying one call option for $50 and leaving the remaining $950 in the bank, novice traders take the entire $1,000 and put it into buying more call options.
They end up buying 20 call options to try to get more bang for their buck. What would have been a 100-share purchase has turned into control of 2,000 shares. Instead of using options to reduce risk, they’ve increased their risk 20 times.
Losing 100% on an over-leveraged trade would be a disaster. And it’s why most folks think options trading is dangerous. But it’s not dangerous if you trade options the way they were originally intended… as a way to reduce risk.
Limit your options exposure to control just the number of shares you would normally purchase. Leave the rest of the money in the bank. Then it won’t be so bad to lose 100% on an option trade. It will almost always turn out better than what you could have lost on the stock.
Best regards and good trading,
P.S. Jeff developed a trading technique that helped him generate millions of dollars for his former clients and retire at age 42. Now, after eight years of development, he’s sharing a breakthrough that allows you to use this same technique yourself, online.
Jeff is offering a half-price subscription to his Pro Trader service today because of a major market “aftershock” that he’s expecting. “For traders, it’ll be like Christmas,” he says. In fact, the last time he saw similar market conditions, you could have turned every $5,000 into more than $64,000 in 48 hours, without touching any stocks…
When you subscribe at half-price today, you’ll get immediate access to Jeff’s “live streaming” website where he shares trades throughout the day… like his Silver Wheaton trade, where he helped readers make a 250% gain in just 14 days. Click here to learn more.