This stuff is simple:
I call it:
The basics of leverage.
The benefits of option trading are that a share price's change can favour the option player without large capital investment.
That's the key: 'without large capital investment.'
If you haven't got large capital that's fine. Most traders being this way.
In fact it is smarter to begin with small capital and grow it through trading than to start with large capital and think it is going to be easier.
It isn't! Because the same hard rules apply to all.
You can still make large profits. Using leverage.
Here's a real price example from my traders notebook.
A blue chip share is trading at around $30.You believe it is oversold and is likely to rise in price.
If you are Mr Big and you buy 10,000 shares your outlay is $300,000.00 (three hundred thousand dollars). This is a lot of money to some but only a little to others.
Let's assume that you are Mr Big, and you do have the $300,000, and you buy the shares.
They perform not quite as well as you expected but OK, and a few weeks later the price is $30.70 cents.
You decide to sell.
You sell and your return is 10,000 x $30.70 or $307,000. Deduct your brokerage, fees, stamp duty and allow for the fact that your money has not been working for you elsewhere, and you may have made something like $6000 clear profit.
In the baldest of terms this is an unexciting 2% profit on turnover.
If the shares had not risen in the desired way you could have been sitting on your 'investment' for a long time without any profit at all.
However you got it right and made 2%.Well done.
If you'd got it wrong you could have invested $300,000 and now be 2% worse off in your capital - and be in a 'hold or sell' position.
Worse of course, you might not have had $300,000.00 to invest. You Might be Mr Average and may have only had $3000.00 to invest.
Suppose you had only $3000.00 to invest and you had bought the real shares just our your $300,000,00 friend, Mr Big, then your profit for this period would have been only cents in the dollar - perhaps not even enough to cover the overheads and fees associated with share trading.
Baldly speaking again. Real share trading with small capital can be very frustrating as, even when you are right far more than you are wrong, you make very little capital gains.
Real share trading is therefore for Mr Big and/or for Mr Medium who wants to trade in the medium to long term in high quality shares.
I'm not knocking it in any way. It's a great place to put some of your trading profits. But it is not a place of fast returns.
Really truly speaking we live in the age of Mr Fast. We want things to happen now.
And although we are only Mr Average we still want things to happen now.
And we can make them happen if we have a good enough plan.
Let us look now at the option alternative.
Using leverage to our advantage.
O.K. Your convictions are still the same.
You like the same share and you believe the price will rise in the short term.
You look at the price of Call Options choosing to buy at the money. Volatility is low and you can buy options with a strike price of $30.00 with almost 4 weeks to expiry for 50 cents. That means you can buy 60 contracts for your three thousand dollars. 60 x 100 x .50 cents comes to $3000.00 plus a little brokerage.
Because you bought at the money your delta will give you a return of approximately 60% of the actual share price movement.
In other words if the price rose 70 cents which we know from the above it did, you would get 42 cents profit, and sell your options for 92 cents.
Your profit of 6000 x 42 or $2520.00 less brokerage.
You cannot pick a high. No one can. You cannot pick a low. So you opt for a stop profit as a part of your plan. And you do have a plan don't you?
Here's how this works.
In reality you would be in a locked in profit as worked out from your Digital Option Trading Plan and your personal beliefs about this share's movement in price, and this may be a mere 30 cents profit to you, as you are not a market watcher (not essential - you can still go to work).
So you activate a stop profit.
Within a few days the share price rises and the option price rises and you take your 30 cents profit.
Your return is 80 cents x 6000 or $4800.00 (deduct your $3000 and you have made $1800 less brokerage all for an outlay of just $3000.
'You have made use of leverage.' You have not invested $300,000.00. 'You have invested a meagre $3000.00.' You are out of the market with $1800 profit and are now looking for your next trade.
¢ The $300,000 person made 2% profit.
¢ You have made 60% profit.
¢ That's leverage.
You are an option trader.
I'll publish lesson six tomorrow.
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