Markets

…and say hello to options trading!

By Lee Lowell  |  June 14, 2018

Over the past few weeks, we’ve talked about how to collect instant income in exchange for an agreement to buy your favorite stock at a price of your choosing.

That’s the beauty of put-option selling. It’s simple and effective.

So effective, in fact, that many readers make tens of thousands of dollars per year following this strategy. If you’re thinking of joining the party, you can do so right here!

A lot of folks write in to tell me how excited they are to try this out. Some have never attempted to trade options before. Some considered options to be too complicated, too speculative, or both.

You now know that’s not the case.

But you may be surprised to learn that put selling isn’t the only safe way to trade options! So, we’re going to take a break from talking puts and shift gears to another strategy that’s worth exploring.

In fact, I should come clean…

…My goal is for you to forget about stocks altogether and embrace options trading!

Not All Options Are Created Equal

Let’s talk call options.

Think of call options as another way to claim a cheap stake in a high-quality stock. This type of move can cost you as little as $15 to control 100 shares of stock.

How? Let’s work with a hypothetical play on Microsoft (Nasdaq: MSFT).

At today’s price of $101.50, buying 100 shares of Microsoft will cost you a cool $10,150.

But you can actually buy an MSFT January 2019 $140 call option as a substitute for buying the stock. This alternative approach will only cost you $15.

That’s right. You can spend a measly $15 to control the same 100 shares of MSFT that costs everyone else $10,150.

That’s the appeal of buying call options: They’re so darned cheap!

But not all options are created equal…

Many investors forget when buying these cheap options that the probability of them paying off is practically nil.

For that cheap call option to pay off (if held until expiration), Microsoft’s stock needs to rally above $140.15 per share – that’s a whopping 38% rise in seven months.

If you take a look at the probability calculator below, the chance of that happening is less than 2%. Conversely, it has a 98% chance of remaining below $140.15

Do you want a trade that has such a small chance of paying off? Didn’t think so.

The call option I just described is “out-of-the-money” (OTM). That is, the strike price ($140) is well above the current stock price ($101.50).

You would need a very large move (38%) by January 2019 to just break even.

Going Deep In the Money

Thing is, there’s a smarter way to play the call-option game that’ll significantly increase your chances of a payoff.

Instead of buying the $140 strike call option, you can buy a January 2019 $80 strike call, an option that’s set well below the current stock price of $101.50.

This is what’s known as a “deep-in-the-money” (DITM) call option, and it has a much higher probability of landing you a profit.

Many investors are unfamiliar with this type of call option. They’re used to picking dirt-cheap OTM options.

But look at the probability results below.

By using the $80 DITM call option, the probability of turning a profit zooms up to 46.6%.

Granted, this call option will cost you $2,285. That’s a far cry from the $15 price tag on the $140 call option.

But the advantages are worth it:

  1. Your chances of booking a profit are greater.
  2. Yes, the $80 call option costs $2,270 more than the $140 call option, but that’s still 77.5% less than buying 100 MSFT shares outright for $10,150.
  3. And the kicker? The $80 call option starts to make money as soon as the stock ticks above $102.85 per share. That’s just a 1.3% bump from the stock’s current price. In contrast, the $140 call option doesn’t make money until MSFT moves above $140.15

Not that scary, eh? It doesn’t stop there.

Next week I’ll break show you how using the DITM call-option strategy can slash your risk by 77% compared to buying the stock outright. Even better, this approach can more than quadruple your returns. That’s over 400%!

Until then,

Lee Lowell

Lee Lowell

A former Wall Street insider and floor trader, Lee Lowell has worked in the market for nearly 30 years now. He began his option trading career in 1991on the floor of the New York Mercantile Exchange (NYMEX) in New York City.Full Bio