Whenever I told people that options are powerful instruments that can help boost your portfolio performance, they are often skeptical as they have heard of many horror stories of how people got burnt with options.
And its true - there are many "gurus" out there selling the dream of using options with a "95% win rate" or how you can make 1000% return in just a matter of days.
I'm here to debunk these myths - yes, the above mentioned is possible, but they only told you half the story.
Beginner's Mistakes To Options
Most beginner investors use options as if they are gamblers, taking unnecessary risks and ended up getting their account wiped out.
It has been my goal to pay it forward and educate investors who are just starting out, which is why I decided to write this blog post.
Before I get started, one thing to note is the options is a derivative of a stock - which means that if you don’t know how to invest in stocks, you shouldn’t touch options in the first place.
If you like to find out more about investing in stocks, check out the following blog posts.
- How To Avoid Poor Quality Stocks (The Funnel Method)
- How To Valuate Stocks (The “Thermostat” Method)
- The “Shopping List” – A Must Have For Value Investors
It is important to be aware that before you use any sort of option strategies - you need to know what stocks to buy first, which is why I highly encourage that you go through the blog posts above, where I used to find quality stocks, and how to valuate them.
The Options "Gurus"
There are many strategies in the options world, some of which have fanciful names such as :
And many “gurus” will tell you many gimmicky stuff about options and how you can use some of these fanciful strategies to get a 95% win rate.
I want to debunk this myth once and for all.
Yes, a 95% win rate is possible.
BUT, you have to understand the concept of payoff ratio.
If you have a 95% chance of winning - and when you win, you make $1 but if you lose, you lose $1000. Do you really want to play that game?
Let’s keep in simple - if we played a dice game.
If the dice rolled anything other than 6, I will give you $1.
But if it rolls 6, you will have to give me $100.
This means that you actually have a whopping 83.3% of winning!
But do you really think that is a fair game?
I don’t know about you, but I hate it when these “gurus” talked about the high win rate, and people who are not aware of this concept ended up wiping their account.
And these are people who were “winning” for 4 to 5 years, and made to six-figures profits. And it just took one trade that went wrong - that “5% chance”, that resulted in a margin call, and got their entire portfolio wiped out.
Can you imagine that? You thought you found a winning formula and were winning for several years and in just a single trade, you gave away all your profits.
Options Strategies For Value Investors
So here’s how I will start this blog post - ignore all these fanciful strategies, and just focus on the basics of options.
Options are essential a contract between a option buyer and a option seller.
In theory, there are 4 most basic option strategies.
For every option, there are four elements you need to take note of:
By the way, I am using options as a value investor - so if you are a trader, this might not be the right blog post for you, I will blog about stock trading in the future.
And I just want to simplify the process to two strategies that are used as value investors.
- Buying Call Options
- Selling Put Options
Let’s focus on these two strategies first, before I discussed about more advanced options strategies for investors in the future.
I will write a more detailed blog post on each of this strategy - for this blog post, I just want to show you the benefits of each strategy, so that you can decide what is the right strategy for you.
Buying Call Options
Buying a call option gives you the right, but not the obligation to buy the stock at a certain strike price.
If you are new to options, you probably may not fully understand what this means. Fret not, there will be future blog posts coming, explaining this in detail.
Here are some benefits of this strategy:
So let me just quickly explain what does buying a call option means using a real example on one of my trades.
You can see that I have a 111.79% return on this investment, which is possible using call options.
I bought a total of 4 call options on BAC at a strike price of 18, and its expiration is 18 Jun 2021. Each option cost me $530, and therefore a total of $2,120.
So what does this actually means?
Well, let me explain.
With every call option I bought, I have the right to buy 100 shares at the strike price of $18, anytime before 18 Jun 2021.
(Yes, one call option represent 100 shares in the US)
This means that I have the right to buy 400 shares of BAC at $18.
BUT, instead of buying 400 shares at $18, which will cost me $7,200...
...I buy 4 call options which only costs me $2,120.
In short, call options allowed me to use lesser money to make much more profits.
And this strategy works best for people who are starting with a small amount of capital, say $10,000.
Because the main benefit of this strategy is that you are able to use a low amount of capital to express your position in the stock market.
And if the investment went south, the most you will lose is the premium you paid.
Read More: How To Invest With Small Capital?
Selling Put Options
Selling put options is all about promising to buy a stock at a certain price.
This is the strategy that I used when a stock is overvalued.
If you have read the my blog post on how I valuate companies using the Thermostat Method, you will probably be able to find some companies that are undervalued.
However, there are also many companies that are of great quality but are overvalued.
A real-life example is that I wanted to buy Facebook at at $150, but it was currently $200.
Now, what do most people do? They will probably wait...and do nothing, or they would go against their own rules, and buy an overvalued stock.
Instead of waiting for it to drop to $150, I decided to sell a put option instead, promising to buy FB shares at $150 each.
And because I made the promise, I get paid a premium for it.
In fact, I have been using this strategy and collecting these premiums every single month - collecting about $700 to $1000 every month - or around 10% of my portfolio every year.
Put Options can be quite complex, so I did a video for my subscribers on YouTube, do check it out down below.
The benefits of selling put options provided me a source of passive income, which are typically much more than dividend stocks can provide.
However, selling put options does require a substantial amount of capital, which is why the buying call option strategy so useful.
Conclusion
Using options to invest boosted my portfolio performance, and it is one of the key strategies that I am using to becoming financially free.
If you are want to learn more about options investing, I encourage you to join my newsletter, and also read my other blog posts right here.
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