There are even complicated strategies involving two or more options contracts working in tandem. Others are designed to generate income if the stock moves sideways. The point is, some options trades are meant to profit from an expected downward move in a stock. And it’s purely for illustrative purposes and is not meant to be taken as a trade recommendation. Keep in mind, this is a rather straightforward example. In other words, the options contract would have turned a routine 15% move in WMT stock into a much larger 60% gain – multiplying your return by four times.
Had you just bought the stock outright, it would have cost you $12,200 upfront (100 shares x $122). Either way, the call option made the most out of WMT’s rally. Alternately, instead of exercising and taking control of the stock, you could simply sell the option for $8 per share (which would be its new price). In percentage terms, that’s a hefty return of 60% ($300/$500). After subtracting the $500 premium, that would leave a net profit of $300. Anything above that level would be profit.Īt that point, you could exercise the option, buying 100 shares at $130 and then promptly selling them in the market at $138, collecting a gain of $800. You would gain $5 per share ($135 minus $130) for 100 shares, offsetting the $5 premium. The breakeven point on this contract would be $135. That’s the tradeoff for a much richer potential payday. So even if WMT stays unchanged, you would lose $500. Therefore, the option would expire worthless.
In that case, there would be no point in buying a stock from the seller for $130 when you could buy it for less on the open market. Suppose Wal-Mart shares stay flat or decline between now and the expiration date. Remember, each contract controls 100 shares, so the total cost to buy the option would be $500. There is a call option expiring on September 18 with a strike price of $130 and a premium of $5.00. As I’m writing this, shares of the retail giant are currently trading at $122. Let’s look at a hypothetical example using a household name, Wal-Mart (NYSE: WMT). In the following example, I’m going to show you how a simple price move can be amplified into a much bigger gain using the power of leverage. They can also generate predictable income while safeguarding against market volatility. In fact, they can be used to minimize losses. While any investment involves the potential loss of capital, options aren’t inherently risky. It’s like putting up a small ante to win a huge pot. Just like Steve did in our example, options will allow you to fully participate in stock movements, while only putting up a small fraction of the underlying asset value – thus magnifying your returns.
By harnessing the power of options, you can take full advantage of those price swings. And how options can be a powerful tool to grow your portfolio.Īs we all know, stocks are constantly pinging around every minute of every trading day. But if you can understand this analogy, then you’re halfway to understanding how that isn’t always the case. “Leverage” is often seen as a dirty word when it comes to investing. That’s the power of leverage: using a modest amount of money to control a larger amount. His outlay was five times smaller, so the return was five times larger. So relative to his $60,000 investment, the $30,000 profit actually represents a gain of 50%. He only made a 20% down payment, handing the lender $60,000. Compared to the value of the home, that’s a return of 10% ($30,000/$300,000).īut here’s the thing… Steve didn’t pay the entire mortgage upfront. Steve decides to sell, pocketing a tidy gain of $30,000 (let’s not worry about realtor commissions). Five years later, the house appraises for $330,000. It’s a nice neighborhood, where real estate values have generally appreciated over time. Steve has just signed the papers and picked up the keys to a $300,000 home. Imagine there’s a guy (we’ll call him Steve) who is about to become a first-time homeowner. But first, I want to start with a simple example. If you’ve never dealt with options before, don’t worry. The secret has nothing to do with which securities you buy – but how you buy them. You can even utilize this tactic with reliable, blue-chip stocks trading right in your own backyard. There is a proven way to magnify your returns that is far less exotic. That’s not necessarily the case, however.
Like scoping out a nano-tech software developer in Eastern Europe or speculating on a South American foreign currency futures contract. So anything that involves the potential to increase your returns more than 10-fold must be extraordinarily risky and volatile.