Financial Literacy

Multiply Your Profits With a Little-Known Wall Street Secret

The market can be a humbling force for any investor, financial analyst or writer. It often runs in the opposite direction than we predict, mocking our best judgment in the process.

Even I’m not immune to making losing calls from time to time…

So whether the market rallies sooner than expected or falls harder than expected, it’s important to have flexible strategies in place.

One way to stay profitable or protected whichever way the market goes is to use the old fail-safe investment strategy: Long-Term Equity Anticipation Securities (LEAPS).

Low-Dollar Risk… High-Dollar Return With LEAPS…

Right off the bat, LEAPS options reduce the amount of money that you’d ordinarily have at risk with a straight stock purchase by up to 90%. So we’re risking only 10% of our capital, with the maximum loss being 10% of what we’d pay to own the shares outright.

That’s a far cry from a 25% stop loss… or worse.

Second, there’s a way of using LEAPS options to reduce risk even further – and potentially enhance returns too.

It’s called a “spread play.”

In a spread, your gains are limited to the difference between two price points (i.e., the price of the options). In return for this limited risk, the gains are also limited.

Let me use an example to illustrate…

Let’s say you have a stock at $20 that you think is headed to $30 by the end of the year.

You look at the $20 LEAPS call options, which are trading $4 per contract – 20% of the underlying share price. Stock market volatility has made them more expensive than usual.

So how can you reduce that cost?

The answer is to combine an options purchase and a sale so that you offset the purchase price.

You buy the $20 call for $4 ($400 per contract) and sell the $30 call for $2 ($200 per contract).

Your net cost is now $2 per contract – 10% of the underlying share price. Remember, there are 100 shares in an options contract, so your actual net cost is $200.

The profit potential is $8 – calculated by subtracting the net cost ($2) from the difference between the strike prices ($10). That’s a 4-to-1 return.

On a 10-contract trade (equivalent to controlling 1,000 shares), that’s an $8,000 profit on $2,000 at risk.

Compare that with what the stock trade would cost. You’d pay $20,000 to make $10,000 – just $2,000 more in profit for $18,000 more in risk.

Takeaway: And what do you give up by slashing your risk?

Well, you cap your gain…

If the stock moves higher than $30, you get no more on your options trade since you sold the right to buy the shares at $30 to someone else for that $2 premium you received.

And while the shareholder would have unlimited upside, holding shares in a volatile market can be risky business. If you want more investment advice like this, and trades recommended in real time, then join me in The War Room today!


About

With more than 20 years of experience, Karim has mastered the subtle art of options trading. What we admire about him is his ability to score huge gains while minimizing the massive amount of risk that often comes with options. Beyond his expertise in options trading, he is also the author of the best-selling book Where in the World Should I Invest? He publishes weekly about smart speculation in his latest free e-letter, Trade of the Day.

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