Increase Your Odds of Investment Success

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If you only invest in stocks you probably think you have a good idea about your risks. But the fact is, if you're a long-only stock investor, you're actually taking on more risk than almost any other type of investor out there.

Because as soon as you buy a stock, you're always assuming a 100% total loss as your worst case scenario.

And while you probably don't believe it - with options, you can control with precision the amount of risk and type of risk you wish to take in any given trade and in any situation.

Yes - really. You can control your risk tolerance down to a single percentage point - or as high as you'd like, and everything in between. And the rewards tend to be commensurate - low risk generally means low reward.

One of my favorite ways to manage my risk is selling vertical call/put spreads like I do in the Options Advantage portfolio.

Let me explain.

An investor, who only trades stocks or ETFs (not options) is bullish, would simply buy a stock - let's say for $50.

At the same time I sell a 44/42 vertical put spread (which is a strategy that bets the same $50 stock  will stay above $44 by options expiration) for $.25 ($1.75 is max risk).

The stock trader picked correctly and the stock rises to $53 by options expiration of the vertical put spread (let's say 30 days) that I traded. However, even by making the right call the stock trader still only makes $3 or 6 percent, but I would have made 14.2 percent on my vertical put spread.

If the stock stayed at $50, the stock trader would have made absolutely nothing (while tying up much more of his capital than I would have to with my vertical put spread). I still would have made 14.2 percent on my vertical put spread.

If the stock dropped to $44, the stock trader would have lost $6 or 12%, and I would have still made the 14.2 percent because the stock did not close below $44, the short strike of my vertical put spread.

As you can see my "probability of success" is greater, but I also limit my return at 14.2 percent.

I don't mind making that sacrifice because what are the chances that the stock will climb 14.2 percent or $7.10 over 30 days?

And remember, if the stock does rise that quickly over by the time my vertical put spread expires what is the likelihood that you are actually going to hold on to the stock?

Many traders would have locked in gains at 5 percent, 8 percent or even 10 percent.

The bottom line is that options get a bad rap, mostly because they are vastly misunderstood by most professionals in the financial world. And if they are vastly misunderstood among financial professionals, how in the world should the retail trader or investor expect to learn about the effectiveness and logical nature of using options?

In many cases, with certain options strategies (long call), the inherent greed of most investors deters them from capping their profits by using a spread strategy. Even if the chance of success is tenfold of what it would be if you bought a stock or even a long call.

That is not my game in the Options Advantage portfolio. I choose to hit a ton of singles and doubles with a high rate of success.

I use statistics to increase my chances of success. Given my aforementioned example, why would anyone choose to buy a stock? Buying stock can take a tremendous amount of capital outlay and only has a 50/50 chance of success. Selling a vertical spread only takes a fraction of the capital and allows me to choose my rate of success based on the short strike that I choose to trade. In my example I chose $44 which has over an 80 percent chance of success. Not even  casino owners get that type of edge. As a seller of options, I do.

So if you're interested I hope you'll take a look at my Options Advantage service. Learn the intricacies of how to effectively trade options. This is a new way to trade options, one that is essentially new to the retail public and it is my goal to teach anyone and everyone willing to listen how to use options in their daily investing lives.

Until Tomorrow,

Andy Crowder
Editor and Chief Options Strategist
Options Advantage

Disclosure: None



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Stocks

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