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It's simple - risk less and profit more on every trade you do.

By Chris Rowe January 9, 2007 Facebook Logo Twitter Logo Email Logo LinkedIn Logo

Most people think that big percentage profits come with big risk.

If you are an options trader, you know how to reduce the power of the market, and therefore reduce your risk. “Reducing risk” doesn’t necessarily mean “taking away from your profit”.

If you know how to use options you have an advantage that most people don’t have. These are not complicated strategies.

If it takes you a few hours to comfortably understand options, and it saves you 1/3 of your stock portfolio, or makes you another 50% on your money, that might be the most profitable few hours that you ever worked in your life. And education is not a depreciating asset. Don't waste another moment. Invest in it TODAY!

Today, my goal is to illustrate a major misconception among individual investors that is keeping you from making earth- shattering returns in your portfolio, while taking VERY LITTLE RISK.

The simplest most basic options play. Buying calls.

You may be under the impression that this is very risky. The type of trade where you can lose the entire investment. Well, you’re 100% RIGHT! So why do I call it “taking very little risk?” I’ll explain:

I’ve got guys that have given me stocks that have done so well it’s mind-boggling.

The last 300% winner was Best Buy (Symbol-BBY) ... how ironic. I got the call with the stock approaching $60. I found call options trading at $2.10 that traded to $9.45 in a day. If I bought the stock I would have made about the same amount.

But the RISK? Read on:

After I hang up the phone, I do some research.

Long story short:

I realize that since July 1999, the stock has seen this price level five times. The stock failed after running into resistance every single time it was at these levels. Each time the stock attempted to break through these highs, it went on to lose as little as 30% and as much as 75% of its value. (Talk about a nightmare. THAT’S RISK!)

The call option that I found simply reduced that risk to $2.10 per share, and it gave me about the same upside as the stock! The key here is to only risk the dollar amount that you would be willing to risk on the stock. If you could afford to buy 5,000 shares of BBY at $60.00, it’s a $300,000 trade. For crying out loud, don’t put $300,000 into the option contract unless you can afford to lose it in a day!

If you would normally invest $60,000 for 1,000 shares of a stock, then you should only invest $2,100 into the (10) option contracts, because that’s essentially all that you are risking (3.5% of $60,000).

You still have the right to buy the stock at $60.00. The problem is that people try this and turn $2,100.00 into $9,450.00 and they say, “WOW why didn’t I do this sooner! I’ll simply turn my $1 million portfolio into $4.5 million.' Then they put that $300,000 into a call option and get wiped out in one day, and then they go tell you that options are the riskiest form of investing and don’t ever do it because you’ll lose everything. Don't listen to that guy. He's wrong.

If you own a stock at $60.00 and it trades to $40.00, you lost twenty points. If you own call options, you only risk the premium that you put up for the contract (in this case it was 2.10 points.)

MY point: you should invest in options similar to the way you should invest in a stock. Only risk what you can afford to lose. And don’t be greedy.

The major winners in the stock market that I know all have one common focus: managing risk. The major losers in the stock market have a common problem: managing greed.

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