Most people say option 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 overleverage their positions – take a bigger position size than they should – and then take a hit. All the option traders I know, including myself, have blown up their accounts at least once.
But it's not the option that's risky… it's the strategy. And when used the right way, options are far less risky than trading stocks.
You see, 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 buying 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 risked buying 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 buying stocks.
But that benefit disappears if you overleverage the trade and take on a larger position with options than you would otherwise take with the stock.
That's the biggest mistake most novice option traders make. Instead of replacing a 100-share purchase with one call option, 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 overleveraged trade would be a disaster. And it's why most folks think option 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 option 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. This past year, Delta Report subscribers have been locking in over triple-digit gains, overnight, on trades spotted by my earnings algorithm.
It's the product of years of work, wins, losses, and lessons learned. Last year, I traded using the system with my own money. And 90.2% of the trades were winners.
If you'd like to know more about how my earnings algorithm works, click here.
If you have a question, suggestion, or would just like to share your thoughts on the market or your trading stories, send in an email right here.
Last week, we asked you if you were making any contrarian bets against the market. A few of you wrote in with your thoughts…
I want to thank you for the dedication you show on a daily basis to the markets and your subscribers. I am always looking forward to reading and learning from your timely comments.
I am a subscriber to a few analytic letters similar to yours and one, only one, has the contrarian view you were asking readers to share.
Best regards, and good reading.
On the contrarian bets side, I think investors need to be really careful in their fixed income portfolios. Complacency is way too high and a marginal change in sentiment could lead to a significant correction. Especially in credit.
With this in mind, if stocks take a tumble or volatility increases significantly the treasury market will be a bid and yields could hold in. I continue to think the bond market is grossly overvalued and ripe for a large correction.
And some words of excitement – and wisdom – from Delta Report subscribers…
I've also made over 80% on your ORACLE earnings trade, even though I purchased options only 15 minutes before end of the day, after I missed it in the morning. Please bring more such awesome trades and ignore trolls.
I think your training videos are excellent, as is your commentary, explanations, and frequent updates. You know this domain very well and earnestly try to help us understand it.
I think I know you from all this exposure, and like most if not all your subscribers, I like and trust you.
It's still a guessing game of probabilities, so we're going to lose sometimes. But as you say… take all the precautions you prescribe – like limit orders, reasonable positions, and timely actions – and we'll win enough in the long run to make this journey worthwhile and profitable.