Long before I found my way to OptionsAnimal, I was involved in the equity markets with the traditional “buy and hold” strategy on individual equities and
mutual funds. I performed my due diligence and invested as wisely as I could. I realized that my strategy had some fundamental limitations – particularly
when it came to how to handle bear market conditions. I knew of no way to protect my portfolio – much less to profit – during volatile markets experiencing
lower equity prices. My only choice was to sell my positions and “wait it out”. This was not always a preferred strategy as it could trigger tax
consequences that would not be advantageous to my longer term investing thesis. I knew that options existed but I had no idea how they worked or how
utilizing them could provide such amazing opportunities. My coursework at OptionsAnimal provided me with the answer to the question,” Why use options?”.
Options provide many advantages in trading our markets. First and foremost is the protection they can provide a portfolio of long equity positions. We know
that markets don’t go up in a straight line forever. Markets have periods of consolidation/stagnancy (as we are experiencing here in the summer of 2013) as
well as periods of bearish activity in which many if not most equities fall in price. The buyers/sellers of options can use these instruments to hedge
portfolio risk. A buyer of a put option pays a premium for the right to sell shares of the underlying equity at a specific price for a specific time frame.
This defines absolute risk in a position during the duration of the put option. Should the underlying equity fall in value, the value of the put option
will rise and provide profit to the put owner helping to offset losses in the equity position. At the same time, a trader can sell a call option on these
same shares. In selling the call, one receives the premium for this option in the form of a credit in exchange for the potential obligation to sell these
shares at the strike of the call during its lifetime. Should the price of the shares remain below the strike of the call, the seller gets to keep the
entire premium received in the sale, once again lowering the cost basis on share ownership. These three pieces – long shares, long put and short call –
create the collar trade. It is a way to maintain equity ownership and “ride out” the bearish markets. You can even structure these instruments to profit
during an aggressive downturn! This dramatically increases your profitability over time.
Another advantage to options buying/selling is the leverage these contracts provide. One options contract controls 100 shares of the underlying equity.
Many traders/investors have a desire to trade equities that are rather expensive and would entertain too much portfolio risk in a single equity position.
Utilizing a long call, for example, that “takes the place” of share ownership allows a method of profiting from equity momentum for a fraction of the
investment. Let’s say you are interested in XYZ trading at $50.00/share. You have performed your due diligence and expect XYZ to rise in price. If you were
to buy 100 shares, this would be a $5000 investment. You choose instead to purchase long calls that will increase in value should your expectation prove to
be correct. Each call costs $500 and has a delta of +.50. This delta calculation reflects how much each call will gain in value for a $1.00 increase in the
share price of XYZ. Assume you take the same $5000 investment and purchase 10 calls. XYZ goes up $5.00. On your 100 shares, this would represent a gain of
$500 on the invested $5000 – a 10% gain. For your options, each option would increase .50 x 5.00 movement or $2.50. Your $2500 gain on this $5000
investment represents a 50% return – leverage in action.
Perhaps my favorite feature in working with options is the ability to create trade structures that can work in multiple trend scenarios. In spread trading,
we create trades that involve well defined risk by selling and purchasing options within one trade structure. As an example, I can use technical analysis
to form an expectation of support/resistance levels that an equity is not likely to trade above/below. I can sell credit spreads outside of these technical
levels that allow the equity to trade in multiple trend directions – as long as it doesn’t go “too far too fast”, I can be profitable. Talk about
advantageous!!
I am incredibly grateful to OptionsANIMAL for the thorough education they provided me in learning to utilize options instruments as my preferred trading
vehicles. The advantages inherent in these instruments provide numerous opportunities for profitability on a daily basis as well as overall portfolio
protection. My trading will never be the same – and that’s a great thing.
Karen Smith
OptionsANIMAL Instructor
