A lot of people email me and tell me it’s a lot of different things, but really it comes down to two things.
It comes down to leverage and it comes down to choice. With options trading you can use leverage to your advantage.
Now obviously leverage can be a bad thing if you use it the wrong way, if you over allocate, if you are stupid with your entries, leverage can work against you.
But one of the key benefits of using and trading options is that you have an incredible amount of leverage to enhance your returns and reduce risk at the same time. The second part of this is choice. When you trade stocks you are very, very limited on choice.
Basically two choices: buy or sell. When you trade options you have a lot of different choices.
You can basically mold or create a strategy that works based on whatever assumption you have about that particular stock. It’s not just buy or sell, it’s is the stock going to be range bound or not? Is it going to move higher or lower? Or is it going to move generally higher, but maybe move a little bit lower? There’s a lot of different ways that you can create and build complex strategies that work to your advantage that is not just limited to the decision of is the stock going to go higher or is the the stock going to go lower, okay? So let’s go through a lot of examples here. We just got a quick screenshot here of a chart of a particular stock. Doesn’t matter what the stock is, but it’s trading around $10, which makes it really, really easy for us to kind of go through.
And again, this is just part of the stock chart, we don’t even need to see what the rest of it is. But current stock price when we took this screenshot was about $10 per share. Now here’s the deal: if you are trading stock you can basically draw a line in the sand here at $10 and that is your decision point. And that’s really it, there’s nothing else that’s beyond that that you can do. Meaning you can either buy the stock at $10 and if it goes higher you make money. Or you can sell the stock at $10, short it whatever the case is, and if it goes lower then you can make money. But this line in the sand is it for you. It’s basically whatever the stock price is right now, $10, 12, 14, 126, whatever the stock price is that is the point at which you make or lose money because you are either going to buy stock or sell stock. Now the benefit to doing that is that you have an unlimited amount of time to be right.
Meaning you can buy stock today and you can wait for 10 years to be right or you can be right over night, or whatever the case is. But you do have an unlimited amount of time as long as you can hold onto the stock and carry that stock with you that you can be right. So that is the biggest benefit in my eyes of seeing the stock and of course that’s discounting dividends and stuff like that which you’ll get along the way.
I don’t think that makes up for the biggest benefit is just holding longevity of the stock. Now when it comes to options, on the hand, you have a lot different choices again or options. And actually let me just back up and say one thing. With stock if you’re going to buy stock, you’ve got to buy it at the current stock price and share price. Meaning that you have to outlay $10 per share. So let’s say we wanted to control or own 100 shares of stock. At $10 we’d have to basically outlay $1000 out of our pocket for the entire position. So now we have $1000 of risk, real risk in the market, that we have out there that if the stock price drops dramatically we’re going to lose money on. So it’s very capital intensive to go out and buy stock and again this is just 100 shares of a $10 stock. We’re not even talking about some stocks out there that are $80, there are stocks out there that are $500, $600 a share.
So to build a position in those requires a lot of capital. And again, if the stock price goes from $10 to let’s say $12, sure you make $200 but you took on, in my opinion, a lot of risk to do that. Because you just basically drew a line in the sand that says hopefully the stock goes above $10 and if it goes to 12 then I make a little bit of money on my $1000 investment in the security. Okay now circling back, if we were to enter an options contract, and I’ll go through a couple different examples here because I think it’s worth it, if we were to enter an options contract and let’s say we were bullish on this stock, then we might go out and we might buy a 12 strike call option.
Now again at this point in the training, if you are going through our track here on Option Alpha, we’ll get into a lot of these call options, put option stuff in a lot more detail but just follow me here because I think the concept is really, really important to understand. But let’s say we think that the stock is going to go higher than $12 and let’s say that this dotted red line here, which is an actual expiration date on our platform, is the point at which we set our expiration. So we basically say if the stock goes above $12, so anything over here basically in this zone, if the stock goes above $12 then we make the difference between 12 and where ever the stock is 14, 16, 18, 20 whatever the case is.
But instead of actually having to buy the underlying stock at $10 a share right now and outlay all of that money, we might be able to control with one option contract we might be able to control 100 shares of this stock for let’s say $50, okay? And that’s just again using some round numbers here so it makes it real easy. But we might be able to buy an options contract at $12 as a strike price and control 100 shares of this stock for just $50. So now if the value of the stock let’s say goes up to $14 by expiration, now we have made a $200 difference in value based on $50 of investment, okay? So now you can see the power and the leverage of options on a very basic example, okay? Maybe not a trade you would do, maybe not a trade that I would do, but it proves the point that you can get a lot more options and choices with less leverage and potentially less risk by using some options contracts, okay? Another quick example and this is now, just to be fair with this 100%, I’m not in favor of buying options as a way of running your business.
We are here at Option Alpha and I am much, much more of an option seller, 95% of the time I’ll be selling options I won’t be buying options. So the way that I structure some of my strategies is the following. I will look at a stock like this and I will say, okay if the stock is trading at $10 a share, I will build an options strategy that profits as long as the stock stays between let’s say $14 and $8 on the bottom side. And again, the specifics of this we’ll go through in further trainings here at Options Alpha, but again the concept is really, really key because this is the difference between stock trading and options trading.
So we’ll build a strategy with options that basically says look, I don’t care where the stock goes as long as it trades in the next month or two months, whatever the timeline is between $14 and $8, okay? So as long as the stock trades somewhere in this range, it can trade at 801, it can trade at 13999, right? But as long as it trades between 14 and 8, between now and expiration, then we take in some premium on this trade or some consideration for selling these options. In that case that might be let’s say $100 or $200 whatever the case is. So now with options, versus just buying the stock outright and hoping it goes up or down, now we can build this framework based on our assumption of where the stock may go or in my case where the stock may not go. So I’ll use probabilities and implied volatility analysis to determine where I think there’s a high likelihood of the stock trading and build a strategy around that so that I profit and give myself a lot of wiggle room. And the reason I love this type of strategy, and this is kind of like our general theme and concept here at Option Alpha, is that I don’t have to be really good at picking the direction the stock goes.
I just have to give myself enough room for the stock to move and still make some money. So in the case of this stock that we’re trading right here, I don’t have to be right in saying I think the stock is going to go higher or I think the stock is going to go lower. I can outlay a little bit of money and basically make an assumption that the stock just doesn’t go as high as 14 or as low as 8 and then I can make some money on my trades. And for me that’s how we create these high probability opportunities. In this case this trade might have a 70% chance of success based on the historical movement of the stock and implied volatility. That is a known number, it’s factual number, we can document that number going through many, many trades and many set ups like this, okay? We can basically pin any trade that we want at whatever probability of success we won.
It is also known that where ever the stock is trading right now there is a 50/50 shot of the stock going higher or lower. No matter what anybody tells you, that is the number. Those are the numbers that have been that way for a long, long time. Every single day the market still has a 50% chance of going higher or lower the next day. Can markets trend, can they move in certain directions? Yes, but every day the stock now has a new 50/50 shot of moving higher or lower into the future. And so we don’t know where it’s going to go. So that’s why I prefer options trading over stock trading. I don’t want to make this 50/50 decision and win on one side and lose on one side. I would much rather build a strategy that says I’m going to win 70% of the time or 80% of the time and I don’t care which way the stock is going to go, okay? So hopefully that was a really good example of how we use options and again the basic overall differences between stock trading and options trading.
Like I said, just to recap, stock trading is one directional and capital intensive for investors. You’ve got to buy the stock and you’re one directional. No matter what anybody says, you are choosing a direction: buy or sell. You’re going up or you’re going down. That’s it. There’s nothing else you that you can do. With options trading, you can use leverage meaning you can put up a little bit of money and control a lot more shares and this reduces risk and it enhances potential profit and you can profit from multidirectional moves in the stock. Meaning you can build strategies that basically profit from multidirectional moves. The stock goes a little up or a little down or stays range bound or sideways, you can still build a strategy to profit around that type of scenario. So in our opinion here at Option Alpha, naturally we believe and we found because we have been doing this for a long time, that options trading gives us much more of a competitive edge in the market than trying to pick directional assumptions. So as always I hope you guys enjoy these videos. If you have any comments or questions, please ask them right below.