Chris’ note: As I’ve been showing you, the traders we feature here at the Cut tend to shine during bear markets.
Take master trader Jeff Clark. He had one of his best trading years in 2008 during the global financial crisis. Now, he’s aiming to do something similar in this bear market.
Like the 238% gain his subscribers had the chance to make on an options trade on Citigroup (C) in July. That’s roughly 24 times the average annual gain for the S&P 500. And Jeff’s trade lasted just two days.
Next Wednesday, August 17, at 8 p.m. ET, he’ll be lifting the lid on a new strategy he’s been working on to make money in this bear market. So make sure you sign up for that here.
Then read on below for more from Jeff on how options can deliver these kinds of gains while keeping your downside risk low.
When most people think of trading options, they think of risk, dangerous leverage, speculation, or gambling.
For new investors it certainly may feel that way.
But that’s because most people don’t understand options.
Think of an options contract as a “side bet” on a stock.
You don’t own the stock directly. But a call option makes money when a stock goes up. A put option makes money when a stock or index goes down.
The reason options were created in the first place was to reduce risk. In fact, options were designed to help investors hedge their portfolios against big falls in the market.
Unfortunately, what’s happened over time is what happens to a lot of good ideas on Wall Street… Options have morphed into a commission-generating vehicle they sell to folks as a way to get rich quick.
If you think trading options will help you get rich quick, I’ve got bad news for you… Although it can make you a lot of money, it’s not going to happen overnight.
Trading is a process. And if you want to do it for any length of time, you have to do it the right way.
That involves a little extra effort. But I can help you master the basics.
I’ve been trading options for more than three decades.
During that time, I’ve also been teaching folks just like you how to reduce risk with options and add a little bit of pop to an otherwise conservative portfolio. So before you start, here are a few things you must keep in mind…
New traders often don’t take the time to learn the right way to use options. They jump right in – thinking, “I’ve got this.”
They gamble, blow up their accounts, then walk away penniless and swearing off options forever.
Even experienced traders sometimes get caught up in the allure of fast gains. They overleverage their positions – take a bigger position size than they should – and then take a hit. All the options traders I know, including myself, have blown up their accounts at least once.
But it’s not the option that’s risky… it’s the strategy. And when used the right way, options are far less risky than trading stocks.
That’s because you risk less money to control a stock in the options market than you do buying the stock outright.
Let’s say you want to buy stock in Company X. It trades for $10 a share. You could put up $1,000 to buy 100 shares…
But you can control the same amount of stock with one option contract. You can buy a contract for, let’s say, $50… and leave the other $950 in your account.
If Company X’s stock goes up, you’ll make money. If the stock goes down, the most you’ll ever lose is that $50. That’s a 100% loss… but it’s a lot less than potentially losing 20% or more of the $1,000 you risked buying the stock.
Between 1978 and 1989, this is what allowed options master Victor Sperandeo to rack up an average annual return of almost 71%… without a losing year.
With that track record, we’d be foolish not to pay attention to what he has to say…
Options are, many say, the riskiest game in town. Certainly, they are by far the most challenging, flexible, and potentially profitable financial instruments available.
But if you trade them prudently, if you apply sound principles of money management, trade only when the risk/reward ratio is highly in your favor, and execute your trades with diligence and patience… Then in all likelihood, you will be profitable over the long term.
To succeed in trading options, limit your trading to opportunities with at least a 3-to-1 payout. At minimum, you want to potentially pocket $3 for every dollar you risk.
This also forces you to think in terms of reward and risk, which is extremely important.
Most failed options traders – even ones that may have had good trading systems – fail because they don’t pay enough attention to risk. If you’re willing to lose 50% on a position, you’d better expect a gain of 150% or more – at least. That’s a tall order.
If you’re willing to lose it all (meaning you could have a negative 100% return on a position), then you’d better be expecting a 300% to 500%-plus gain in that position.
When you see it in terms of risk versus reward – and you realize that 500% winners don’t come along every day – you can see that betting the farm on one trade is a bad idea.
Options are a lot like poker – your current hand is only part of the picture. Betting appropriately for the entire game is really what’s important, which leads us to…
You’ve got to know when to hold ‘em and when to fold ‘em.
But you’d sure hate to fold and take a total loss with a big bet on the table… So don’t ever put yourself in that situation. Limit the size of your positions.
You should only risk 2–3% of the money you’ve set aside for trading on any one trade. I can’t imagine any combination of circumstances where you should consider putting more than 10% of your trading money on one play.
To end up like Sperandeo and profit over the long run, you’ve got to stick to the program. Limit the size of your positions. And limit your downside by never allowing a small loss to turn into a big loss.
Traders who follow this have a chance to win in options over the long run. Those who don’t will be quickly taken for every penny.
Best regards and good trading,
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Jeff Clark
Editor, Earnings Trader
P.S. Don’t forget to sign up for Jeff’s upcoming options trading masterclass next Wednesday, August 17, at 8 p.m. ET.
Jeff has identified a “special situation” in the market. It’s a short window that’ll allow you to potentially double your money every day for the next 42 days.
And as Jeff will show you during his event, this “special situation” is 100% predictable thanks to a federal law (Section 13 of Public Law 73-291). So make sure to secure your free spot for Jeff’s training here.