An Advanced Options Trade
The Dynamic Wealth Report
March 2, 2010
Many of our readers focus on trading stocks and ETFs in the market. While you could spend a lifetime learning about and perfecting trading
strategies on these securities, others expand their horizons. There are
a number of other trading opportunities available for investors willing
to put in the work and learn about new strategies.
Take commodities for example.
For years, experienced traders stayed away from the commodity markets
because of their complexity and risk. Trading futures with huge levels
of leverage was risky… you could lose more money than you invested. The
phrase “losing your shirt” takes on a whole new meaning.
Today, trading commodities is a whole lot easier… new commodity ETFs
mirror fluctuations in commodity prices.
It’s the same with currency trading.
An entire market, once off limits to ordinary investors, is now
available to everyone. You don’t have to be super wealthy! Anyone can
trade currencies… right in their regular stock trading account. Once
again, the magic of ETFs make it possible.
Now, there is one area of opportunity for huge gains… but the trading
strategies can be a bit more complex.
I’m talking about trading options.
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My first trade in the stock market (way back when) was actually an
options trade. I didn’t have enough money to buy 100 share blocks of
stock… so I started trading options.
Now, options aren’t for the faint of heart.
If the stock trades above the strike price before the expiration date,
your call option becomes very valuable… and if it doesn’t… well, the
option could become worthless.
So why take on the risk?
For the potential rewards… I’ve seen options skyrocket in value…
returning 200%, 300%, or even more within a few short weeks.
In my Currency Options Insider service, I recommended buying put options
on the British Pound. Less than two months later, the option had
increased
in value by 1,027%... just thinking about it makes me smile.
Can you imagine turning every $1,000 invested into $10,000?
Obviously, every trade doesn’t work out like that… but you only need a few big
winners to make some serious money. Option trading can get a lot more
complex. Here’s an advanced strategy for those of you who have traded
options before.
It’s simply called a spread trade.
When you buy an option (a call or put), you’re banking on the stock
moving one direction or the other. However, buying the option can get
expensive. You need to come up with the cash to purchase the option.
Instead of fronting all the cash, you can sell a similar type option
and uses the proceeds to offset some of the costs.
Some advanced traders (like hedge funds) use spread trades to lower
their cost of trading options.
Here’s a real life example…
Right now you can buy Citigroup (C) call options with a $3 strike price
and a September expiration for $0.64. To reduce your cost, you can sell
the same number of call options with a $4 strike price and a September
expiration for $0.21.
You simply buy one set of call options and sell another set.
Why would you do this?
The proceeds from the sale of the call options help reduce your overall
cost by over 32%. When all is said and done, you’ll pay something close
to $0.43 instead of $0.64. Remember, the price of the option is
multiplied by 100 to get the total cost of one option contract… In this
case, you’ll pay $43 for each contract.
How do you make money?
Your break-even on the trade is $3.43. (Simply add the cost of the
option to your strike price.) As soon as Citigroup trades above $3.43,
you’re making money. Remember, you’ll have until September for this to
happen.
Your maximum profit is when Citigroup hits $4.00… so you’ll make $57 per
contract. It doesn’t sound like much, but you could buy 100, or even
1,000 contracts.
If Citigroup trades above $4.00, your profit is capped. Remember, you
sold the $4 option to somebody else… so while you can use your call
options to buy Citigroup at $3, you’ve agreed to sell it to somebody
else at $4.
This strategy caps your total return. But, you were able to reduce your
overall cost of doing the trade.
I’ve just scratched the surface of advanced trades here. You can create
spread trades in a number of ways including calendar spreads, diagonal
spread, vertical spreads, horizontal spreads… the list goes on and on.
Once you understand how the trade works, it can be a very powerful
strategy.
Remember, this is an advanced strategy. You might need additional
permissions in your trading account. Most importantly, if you’re
confused at all, consult your broker – that’s what they’re there for!
We’re two months into the New Year and the IPO market has been
difficult. A number of offerings have fallen shortly after starting to
trade. And, a huge number of IPOs have been pulled from the market
because of weak demand. This isn’t a good sign for the market overall.
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