7 Steps to Success Trading Options Online - Traders' Library

position one of the more exotic “delta neutral” strategies, such asa straddle or “strangle.” If you own a stock and need to generatemore income from your holdings, you might add an option to themix and write a covered call. Or, if you own a large selection ofstocks and want to protect yourself against a market downturn,you could choose to buy puts on a broad-based stock index.In short, the strategic possibilities — like the potential profits offeredby options — are virtually unlimited. Whatever your specific goal,you can probably find a way to achieve it using options — assuming,of course, that you are correct in your assessment of what themarket (or a given stock) is going to do, and that you structureyour option strategy properly. We can’t do much to ensure you arecorrect in evaluating the market — beyond perhaps urging diligencein your research and economic monitoring. However, we canshow you when and how to implement some of the key optionstrategies — so we will.The Strategic Starting Point — Buying an OptionThe most basic use of an option is as a purely speculative vehicle.In fact, a recent market study found that 68 percent of all optiontrades during a five-year period involved the simple speculativepurchase of a put or call. (Call buyers accounted for roughly 70percent of that total, a function of the inherent tendency for investoroptimism.) The reasoning behind this statistic is easy tounderstand. When you buy an option, your initial cost is low — farlower than if you traded the stock underlying the option. In addition,your risk is strictly limited to the amount you pay for theoption. However, your actual dollar profit potential, which is unlimited,can be almost as large as with the actual stock — and yourpercentage return on a successful trade can be 10, 20 or even 30times larger.Thus, it’s no wonder that buying options is such a popular speculativestrategy. Unfortunately, it’s also one of the least successful —with some studies putting the number of losing trades above 90percent. Once again, however, that represents a weakness in theoption buyer’s market analysis or timing, not a flaw in the strategy.And, so there won’t be any flaws in your strategy when you7 Steps to Success Trading Options Online 33