That's OK. I want to use today's essay to explain some of the basics and demystify options so that you can use them to amplify your profit potential and limit the downside. The truth is, options can be as simple or as complicated as you want to make them.
Just know that when you purchase options as a means to speculate on future stock price movements, you are limiting your downside risk, yet your upside earnings potential can be unlimited. Aside from speculation, investors also use options for hedging purposes. It is a way to protect your portfolio from disaster. Hedging is like buying insurance -- you buy it as a means of protection against unforeseen events, but you hope you never have to use it.
The fact that you hold insurance helps you sleep better at night. Today, I want to talk about one of the most basic ways investors use options: buying call options. Investors generally buy calls on stocks they expect to move higher. But rather than simply buying shares, savvy investors use calls to amplify their upside.
Let's take a look at a theoretical example to see how this works. Not bad.
But many of my Profit Amplifier readers choose to trade with larger position sizes, so that's why we use deep "in the money" calls that have a higher probability of being profitable. We also use stop-loss orders. After all, there's no sense in being greedy when we can protect ourselves and still profit. Buying call options is one of the most basic and common options strategies, and you can use it as a substitute to simply "going long" and buying a stock.
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And by taking a sensible approach to our trading strategy, we've come out ahead more times than we've lost. Aside from a few road bumps, our path to success has been very profitable. In fact, my readers and I have made an average return of The bottom line is, if you've never considered using call options as a way to amplify your gains, now is a great time to start.
I've put together a short presentation that explains how options work and more details on how my Profit Amplifier readers and I have been able to achieve our record of success. If you sign up for my newsletter, I'll also send you five special reports that will help you get started, including a Brokerage Guide, an Options course and my special "Black Book" of trading secrets.
To learn more, simply visit this link. It offers both limited losses and limited gains.
The Basic Tools for Successful Binary Trading
The trade-off when employing a bear put spread is that your upside is limited, but your premium spent is reduced. If outright puts are expensive, one way to offset the high premium is by selling lower strike puts against them. This is how a bear put spread is constructed. This strategy is often used by investors after a long position in a stock has experienced substantial gains. This is a neutral trade set-up, meaning that you are protected in the event of falling stock, but with the trade-off of having the potential obligation to sell your long stock at the short call strike.
Again, though, the investor should be happy to do so, as they have already experienced gains in the underlying shares.
This strategy allows the investor to have the opportunity for theoretically unlimited gains, while the maximum loss is limited only to the cost of both options contracts combined. This strategy becomes profitable when the stock makes a large move in one direction or the other.
An investor who uses this strategy believes the underlying asset's price will experience a very large movement, but is unsure of which direction the move will take. This could, for example, be a wager on an earnings release for a company or an FDA event for a health care stock.
Losses are limited to the costs or premium spent for both options. This strategy becomes profitable when the stock makes a very large move in one direction or the other. All of the strategies up to this point have required a combination of two different positions or contracts.
The Basics of Options Profitability
All options are for the same underlying asset and expiration date. For example, a long butterfly spread can be constructed by purchasing one in-the-money call option at a lower strike price, while selling two at-the-money call options, and buying one out-of-the-money call option. A balanced butterfly spread will have the same wing widths. An investor would enter into a long butterfly call spread when they think the stock will not move much by expiration. Maximum loss occurs when the stock settles at the lower strike or below, or if the stock settles at or above the higher strike call.
This strategy has both limited upside and limited downside. In this strategy, the investor simultaneously holds a bull put spread and a bear call spread. The iron condor is constructed by selling one out-of-the-money put and buying one out-of-the-money put of a lower strike bull put spread , and selling one out-of-the-money call and buying one out-of-the-money call of a higher strike bear call spread. All options have the same expiration date and are on the same underlying asset. This trading strategy earns a net premium on the structure and is designed to take advantage of a stock experiencing low volatility.
Many traders like this trade for its perceived high probability of earning a small amount of premium. The further away the stock moves through the short strikes lower for the put, higher for the call , the greater the loss up to the maximum loss. Maximum loss is usually significantly higher than the maximum gain, which intuitively makes sense given that there is a higher probability of the structure finishing with a small gain. In this strategy, an investor will sell an at-the-money put and buy an out-of-the-money put, while also selling an at-the-money call and buying an out-of-the-money call.
It is common to have the same width for both spreads.
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The long out-of-the-money call protects against unlimited downside. The long out-of-the-money put protects against downside from the short put strike to zero. Profit and loss are both limited within a specific range, depending on the strike prices of the options used. Investors like this strategy for the income it generates and the higher probability of a small gain with a non-volatile stock.
The maximum gain is the total net premium received.
Options Trading Tips & Strategies to Get Started - RagingBull