Mike’s note: For today’s Market Minute, Jeff thought it would be a good idea to remind traders of an important trading strategy to follow.
In fact, Jeff put this strategy to use in a recent presentation where he gave his 18-year-old son Carson a crash course on options.
If you’re interested in seeing if Carson was able to double his money by following his father’s advice, you can still watch it here – but don’t wait, this presentation won’t be online for much longer…
By Jeff Clark, editor, Market Minute
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. They 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. If you’re new to options… or are skeptical if it’s the right trading strategy for you… then you’re not alone. But I believe anyone can trade options, even my 18-year-old son Carson.
Which is why yesterday, I hosted a special presentation from my California home to showcase how easy options can be if you just follow my simple techniques.
I used these techniques to help guide Carson through the same process I use with all my trades, but was he able to meet my challenge and double his money on a single trade?
Click here to see for yourself…
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