5 Foolproof Reasons You Should Be Trading Options
With a little guidance, options trades can be a safe and effective way to supercharge the returns in your portfolio. Just see what our lead options analyst Alan Knuckman has to say about his 100% return trade from September and how he regularly scores wins just like that.
This is the Power Of Options. A 100% Profit Power Play on Freeport McMoRan Follow Up from Sep 6th
The straightforward strategy of using options to go long saw super-sized FCX returns in two months. Click here to view the original recommendation.
“September 6th Trade Setup: I recommend the Freeport McMoran (NYSE: FCX) January $8.00 Call at $3.25 or less. Only a close in the stock below $9.00 on a weekly basis or the loss of half of the option premium would trigger a position exit.”
The $300 investment has DOUBLED to $600 in just two short months. The stock has moved from $10 to the $14 annual highs.
Instead of buying Freeport McMoRan shares at the $10 price floor that had held for many months, a stock substitution play using a limited risk call option was much cheaper than paying for the stock itself.
This successful strategy had five main benefits over a stock purchase.
1) Less investment cost – $300 versus $1000 for 100 shares
2) Absolutely limited risk to the premium paid with exit stop at half.
3) Staying power to effectively be long FCX from $8 for four months.
4) Modest option breakeven level just 50 cents higher.
5) BETTER RETURN of 100% in two months.
SIMPLE STOCK SUBSTITUTION STRATEGY SUCCESS
A stock substitution strategy using options ties up less capital and has absolutely limited risk to the premium paid. Option contracts also have greater staying power for long-term trend development.
Buying an In-The-Money option gives you the right to long the shares from a lower strike price and it costs much less than purchasing the stock itself. This is how you turn a couple dollar improvement in this stock into a 100% gain.
The Options Way: Unlimited Upside Potential with Limited Risk.
The FCX long call option can provide the staying power in a potentially bullish trend extension. More importantly, the maximum risk is simply the premium paid.
One major advantage of using long options instead of buying or selling shares is putting up much less money to control 100 shares; that’s the power of leverage.
Choosing an option can sometimes be a daunting task with all of the choices and expiration months. Simply put, traders want to buy a high-probability option that has enough time to be right.
The option strike price is the level at which you have the right to buy without any obligation to do so. In reality, you rarely convert the option into shares. Simply sell the option you bought to exit the trade for a gain or loss.
There are two rules options traders need to follow to be successful.
Rule One: Choose an option with 70%-plus probability.
The Delta is a measurement of how well the option reacts to movement in the underlying security. It is also important to buy options that payoff from only a modest price move.
There is no need to ONLY make money on the all but infrequent long shot price explosions.
Good options can profit from only modest directional moves.
Any trade has a fifty/fifty chance of success. Buying In-The-Money (ITM) options increase that probability. That Delta also approximates the odds that the option will be In-The-Money at expiration.
Buying better options are more expensive, but they are worth it. The chances of success are mathematically superior to buying cheap, long shot, Out-Of-The-Money lottery tickets that rarely ever pay off.
Rule Two: Buy more time until expiration than you may need – (even if the move occurs in the next few weeks.)
Time is an investor’s greatest asset when you have completely limited the exposure risks.
Traders often buy too little time for the trade to develop. Nothing is more frustrating than being right but only after the option has expired prematurely to the market move.
FCX stands at the top of what has developed into an eight-month trading channel between $10 and $14. An upside breakout targets a technical measured move at $18.
Remember this was a $30 stock just two years ago.
The January option has more time for development with two months until expiration.
I love sharing these options trades with you, and I especially love it when they work out as planned like in the above case. I don’t have any new trades for you this week, but my colleague Tim Plaehn has just highlighted three high-probability trades that he wants to share with you.
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Note: The author of this article is Alan Knuckman.
Category: Options Trading
