Chris’ note: We spill a lot of ink in these pages on the “what” of investing. We track trends, spot opportunities, and identify contrarian setups. This week, we’re doing something a little different… and focusing on the “how.”
Yesterday, you heard from former hedge fund manager Teeka Tiwari on the three-step action plan he used to achieve financial freedom… and how you can use it to start living your dream life.
Today, we turn to master trader Jeff Clark on how to build your wealth through trading… without blowing yourself up.
As he reveals below, most folks view trading as risky. But if you use the right strategy, that couldn’t be further from the truth.
If you ask most folks about options trading, they’ll tell you it’s risky.
And some people do blow themselves up with options.
But it doesn’t have to be that way.
You can use options – which are “side bets” on stocks – in a conservative way.
For instance, from 1978 to 1989, options master Victor Sperandeo racked up an average annual return of 70.7%… without a losing year. As he put it…
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.
Sperandeo is right. And following these simple principles has allowed me to profit even through major booms and busts without blowing up my account.
That includes the dot-com crash when I booked gains of 1,391% in 78 days… 1,263% in 68 days… 1,007% in 42 days… and 1,285% in 48 hours…
I also clocked triple-digit gains 10 times following the 2008 financial crisis… And 14 times in the wake of the 2020 crash.
So, let me show you how I trade options the conservative way…
These Trades Generate Regular Income
First, you should only trade with a small percentage of your overall portfolio.
I recommend you use about 10% of your liquid wealth to fund a trading account.
To make the math simple, let’s say you put $100,000 into that account.
You want to put $80,000 to work in a low-risk, conservative trading strategy.
My favorite is selling uncovered puts. It’s a way to generate extra income for your account.
When you sell a put option, the buyer gives you cash up front. In return, you agree to buy shares in a company you want to own if its share price falls below a certain price – a strike price.
You don’t put all that money to work on one trade.
You take your $80,000, and you divide it by 10. So, using this example, you allocate no more than $8,000 for each uncovered put you sell.
There are only two outcomes for this kind of trade…
The stock you’ve sold puts against stays above its strike price. The put option you sold expires worthless. And you keep the upfront income you collected.
Or the stock you’ve sold put against falls below its strike price. In this case, you’re obliged to buy the stock at the discount you agreed to. And you keep the upfront income you collected for selling the put.
It’s the closest thing to a win-win I can think of.
You then use the income you generate this way to fund the speculative side of the account…
Speculate Without Risking It All
You want to speculate with the remaining 20% of your account…
And you do that by buying call and put options.
When you buy a call, you pay upfront income to speculate on a rising stock price. When you buy a put, you pay upfront income to speculate on a falling stock price.
Thanks to options math, this gives you leverage – or extra oomph – over the moves in the underlying stock.
That’s why buying puts and calls is so exciting. It’s thrilling to think about earning 100%, 200%, or more in a few days.
And like with the other part of your trading portfolio, you want to always be diversified.
So, in our example, you’d divide that $20,000 by 10. That gives you $2,000, which is most you should put into one trade.
The reality is that not every trade is a winner. You’re going to have losers as well as winners. By keeping each trade relatively small, you make sure a loss never wipes you out.
And if you’re selling uncovered put options with the conservative part of your account, the income you’re generating will make up for that loss.
That’s what so few people understand about options…
Less Risky Way to Trade
When you use them the right way, options are less risky than trading stocks.
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 spend $1,000 to buy 100 shares…
But you can control the same amount of stock with one option contract. You can buy an option 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.
Most people will still think that options trading is risky. But if you apply sound principles of money management, that couldn’t be further from the truth.
Best regards and good trading,
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Jeff Clark
Editor, Market Minute