understanding the stock market, trend trading stock

I have to say I sometimes get tired of hearing people say how dangerous option trading is. Of course trading options can be risky, but what about buying a stock? If you pay $50 a share for a stock, what is the risk? It is $50. If one bought an "at the money" LEAPS call (giving the right to buy the very same stock for the same $50 anytime before expiration as much as 2 to 3 years away) for say $9, the risk would only be $9. Which is better? Yes, the call will eventually expire, but there is no requirement that it be held to expiration. There is risk that the value of the call will erode because of the passage of time, but if the stock price moves up, the call price will, in all probability, also move up. If the stock moves down $10, there is a $10 loss for the shareholder, but the call owner will probably still have some value (particularly if there is a fair amount of time left to expiration) and, at worst, would lose no more than $9 while the stock owner loses $10. At the same time the loss is limited to the amount paid for a directional option, the potential profit is unlimited and, in terms of percentage returns on investment, the directional option offers a significantly higher potential.

Puts, too, offer some exciting possibilities. Has your broker told you you can insure your stock position by purchasing puts? Selling puts can also bring in income and may enable the trader to buy stocks at wholesale prices.

Options in combination with stock purchases can create very low risk, sometimes even no risk positions. The bottom line is that I believe options are worthy of study to gain the understanding necessary to use them effectively.

Don't be surprised, however, if your full service broker tries to dissuade you from even studying options. The fact is that many brokers, believe it or not, know little or nothing about options trading. The large full service firms generally do not want options traders and actively discourage them. In fact, many of their brokers know little about options trading and are not even permitted to do it for knowledgeable clients. It is fine with the full service broker to permit you to put yourself at risk for the full price of a stock, but, God forbid, you want to buy a directional option that limits the risk to the price paid for the option yet provides unlimited upside potential. That is something they just don't want you to do.

At the recent OptionsXpress Expo, one of the opening speakers quite appropriately suggested that some of the big full service brokerages treat options traders as lepers. My advice is to avoid the big firms if you are interested in trading options and find a firm that caters to your business -- not just theirs. Education, of course, is paramount before engaging in any trading, particularly option trading. Once some education is obtained, do not trade real money until you have paper traded any given strategy successfully over a period of time.

Good Trading!
Bill Kraft

Mr. Kraft's past articles are posted on our website for your review.

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