OPTION TRADER -- by Bill Kraft
Bill Kraft
Editor |
Our Option Trading Service is for conservative traders that understand leverage principles. We focus on powerful option trading strategies that place volatility and momentum in your favor. And we pride ourselves on minimizing our losses. We always know our downside potential in a trade.
Option trading is often considered to be very risky and it
certainly can be. However, one of the nice things about many option
trades is that the risk is limited and is often much less than the risk
of stock ownership. Take, for example, a trade I recently made on
Reynolds American (RAI). With the stock trading around $90 a share in
early December, I bought 5 of the Jan '07 $90 calls for $8.70 a share.
Since each contract controls 100 shares, I controlled 500 shares of RAI
for $4,350 plus a commission of $12.95. By buying the call options, I
had the right, but not the obligation, to buy RAI stock at any time
until expiration in January 2007 for $90 a share (no matter how high the
stock was trading). Of course, as the price of the stock rose, the
value of my calls also rose. Had I chosen to buy the stock at $90 a
share instead of buying the calls, I would have invested $90 a share
times 500 shares for a $45,000 investment (instead of the $4,350 the
options cost me).
By buying the calls, I controlled the stock. I gave up the right
to collect dividends and I gave up the right to vote in corporate
elections. However, I only had to invest $4,350 instead of buying the
stock for $45,000!!! My risk was limited to my investment. In other
words, even if the stock went to zero I could not have lost more than my
investment -- $4,350. If I had bought the stock, my risk would have
been more than 10 times greater or $45,000! Yes, owning these long term
calls was risky to the tune of $4,350, but it was not nearly as risky as
owning the stock and risking $45,000.
Now, let's look at return. I owned my options for only 10 days and
sold them for $10.30 a share after the stock moved up. After my
commissions, I enjoyed a $773.88 profit on my $4,350 investment. That
is a 17.7% return after commissions in only 10 days. When I sold my
options, the stock was trading at about $92.85, so had I bought the
stock for $45,000, I would have made a $2,850 profit before commission,
but only a 3.1% return on my investment.
Obviously, by choosing to buy the call option, I had a lesser risk
than I would had I bought the stock. I reaped a 5 fold greater
percentage return than I would had I bought the stock. Of course, though
buying a call option generally offers a much lower dollar risk and a
much higher percentage return than buying the stock, it must be
remembered that options do expire. So, if one buys a call and the stock
doesn't move up (sometimes very quickly), the whole investment can be lost.
The knowledgeable trader makes careful decisions about what
expiration to buy, what strike price to buy, and how much he can pay for
a given option. Under the right circumstances, buying a call option can
be a very powerful strategy as illustrated by my RAI trade.
Here's the quick details of another recent trade:
Details Here.
SUCCESS TRADING GROUP -- by the Success Trading Group Team
