Use Options for Leverage and Limited Risk
Buying calls and puts to trade a directional view is one of the simplest ways to get started trading options. Receive updates via e-mail, text message and mobile app as new ideas are identified. Gain exclusive access to our professionally analyzed price charts. Buy or short the stock or use options for leverage and limited risk. Join us on line every week for our Break Out Trader Analytics, designed to give you a deeper understanding of trade entry and exit as well as risk management and trading discipline. Join us live on line, or watch the archived recording.
In order to use options effectively, we need to understand the basics. If we expect a stock to strengthen, we can buy shares or, as an alternative, we can buy a call option that gives us the right to own those shares at a specific price, for a specific time.
Conversely, if we expect the stock to weaken, we can sell short the shares, or we can buy a put option that gives us the right to sell the those shares at a specific price and for a specific time.
Buying Call Options For Leverage and Limited Risk
Remember that we can buy a call option as an alternative to buying shares in a stock. The value of the call option will increase as the value of the stock increases, allowing the call option holder to profit. Since we cannot lose more than the premium paid for the option, using a call option as an alternative to buying shares allows us to participate in a bullish opportunity with a limited and identifiable risk exposure.
When buying a call option, we can purchase 1 call contract for every 100 shares that we wish to control. We are in fact paying for the right (not the obligation) to buy those shares at a specified price (known as the strike price). We can sell that option at anytime to lock in a profit or cut our losses. This right is valid for a specified period of time. As an option buyer we can select a time frame that suits our objective.
Buying Put Options For Leverage and Limited Risk
You can use put options as a means of protecting the sale price of stock you own (Hedged Position Trades) or you can use them as an alternative to shorting. By using a put option, we can profit with a limited and quantifiable risk exposure if the share value of the ETF drops.
Similar to buying a call option, we would buy 1Put for every share 100 shares we would like to control. We are essentially paying for the right to sell those shares at a specified price (known as the strike) regardless of how low the stock trades. The put option will increase in value as the stock drops. We can sell that option at anytime to lock in a profit or cut our losses. This contract is valid for a specific period of time.
Options are a powerful tool for speculating on stock opportunities with a limited and identifiable risk exposure. We can control stock with less capital than it would take to buy the underlying shares offering an increased % rate of return. We can use options inside and outside of our RRSPs and 401k’s to generate cash flow, protect and preserve our capital and speculate on market movement in combination with stock or simply buying and selling the options on their own.
For an example of how traders and investors are using options to leverage their capital and limit their risk check out this blog on how you can Trade the Big Players With Options as a Stock Replacement.
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