Are you finding it difficult to generate income buying and selling stocks? Well you are not alone! That’s why many traders turn to specific options strategies to set up higher probability/defined-risk trades specifically designed for markets just like this. Although many investors buy and sell stocks, a pivot to options can be difficult without a guided transition.
One popular misconception about options is that they are too complicated or risky. Strategies like option puts and option calls, in reality, can reduce risk and provide certain advantages over trading single stocks. It’s worthwhile to understand what these advantages are, and then consider augmenting your portfolio with options strategies. If you can create a hedge for your portfolio or generate a steady income by trading options against the underlying stock, you can greatly improve your monthly returns. So, let’s see what those advantages are.
1. Cost Basis Reduction
Options allow you to reduce your cost basis. For example, if you are planning to buy shares of Apple at $135, you can execute an options strategy, and get the same stock at a reduced price of, say $130. By using options, you can usually get 1-3% cost reduction for the underlying asset that you are trading. This in turn can help in improving your probability of success to more than 75%.
2. Increased Probability of Success
As seen earlier, trading a stock is a binary event and has a 50-50 chance of increasing or decreasing in value. The stock market is essentially a chaotic system. Even with fundamental and technical analysis, you cannot accurately predict a random event or external shock that impacts the market. Because options increase your probability of success by way of cost basis reduction, you give yourself better chances of being on the upside of these 50-50, or binary events. This is a significant edge that you are gaining. So, even though options could be directional trade, they can also be a market neutral trade. And, if you look at the Statistical Analysis, you will find that by trading small and trading often, and doing it over and over again, month after month, you will see an improvement in your portfolio compared to trading stocks alone.
3. Efficient Capital Leverage
It also allows you to leverage your capital. Consider an average trading account with $10,000. It can’t buy a stock like Priceline (PCLN) that trade around $1,900, or can only buy one share and try to sell it for more than 10% of the account. Clearly, it’s difficult to participate in great stock like Alphabet (GOOG), Amazon (AMZN), or Priceline. If a stock has underlying options, you can participate with options trades at a fraction of the stock price and provide greater leverage.
4. Limiting Risk
You can limit your risk with options as well. What’s most frustrating to traders is when, even after being correct on the direction and timing of the market, they still sustain losses in an account due to short-term volatility. By trading options, you can limit your downside by allowing yourself to withstand Short-Term Volatility. You can sometimes have unlimited upside if you trade in options. In effect, options may give you limited loss and unlimited gains! The fundamentals of options trading are easy to learn too.