Today Let's Bury a Costly Myth

It's about managing your risk. [Image]( Today Let's Bury a Costly Myth Dear Reader, Hi, Chris here... I wrote the following bite-sized bit of education a while ago, but I get a steady flow of emails asking about it. It's about a very simple concept that many folks misunderstand -- leverage. Chris Rowe Founder True Market Insiders Let me begin by saying that I consider leverage to be such a key investing concept, because of the three pillars of investing -- what you invest on (allocation)... when you invest (market timing)... and how you invest (risk management)... Risk management is hands down the most important! Now, if I could literally force individual investors to make one single change to their investing habits, I tell them: Learn to trade options! It’s sad how many investors are leaving cash on the table by not trading options. Especially when the avoid options thanks to a lie they've been peddled by the media and by so-called "gurus" who should know better. And the biggest myth about options is that they are dangerous and risky to trade. Not true! Whenever I hear about someone taking a massive loss trading options, my first thought is always, “I bet they used leverage the wrong way.” Say they have $10,000 to put into a trade. Say the stock they like trades for $10. They could buy 1,000 shares of the stock. They could buy a Call option costing, say, $1.00. For $100 they control 100 shares of that same stock. That means for $1,000 they control 1,000 shares. Same as with the $10,000 straight stock scenario. Here comes the mistake... Instead of spending only $1,000 to control 1,000 shares... they decide to spend the entire $10,000 and control 10,000 shares. This is a position size WAY out of proportion to their original plan. It's using leverage the wrong way. And it's ignoring the core principle --risk management is the most important part of investing! It's not necessary to use a huge amount of leverage o make money with options. You already get a large benefit without doing so. The reward to risk ratio is much higher if you just apply a options "stock replacement strategy" in a responsible way. To understand this concept, which I call "Smart Leverage," you first must understand the “delta” of an option. Let's use Block, Inc. (SQ) as an example. Please understand that I am not recommending you buy SQ or trade options in it. This is just an illustration and the charts are historical charts. In the (again, historical) image below, we see the options chain for SQ. I’ve highlighted the September 67.5 strike Call option.     The delta of this particular option is .75 (or, said out loud, “a seventy-five delta”). The delta measures the price sensitivity of the Call option value relative to the stock price movement on a one point (one dollar) move in either direction. A standard equity options contract is for 100 shares of an underlying stock. Thus, if the stock in question advances (or declines) by approximately one point, the Call would gain or lose about $0.75 or $75.00 per contract (even though 100 shares of the stock would gain or lose $100.00). In other words, since the delta is .75, if the stock gains or loses one point, this call option should move up 75 cents, from about $22.50 to $23.25 (up) or down 75 cents, from $22.50 to $21.75 (down). Thus, if you would normally own 1,000 shares of SQ, which would be approximately $80,500.00, with the stock trading for $80.50 you could instead own 10 of these call options (10 calls controls a 1,000-share stock position). Since this call has a delta of 75, it would have a similar effect of owning 750 shares (not 1,000). Since the delta is 75, if the stock advances one point, the 10 calls would gain about $750.00 (75 cents per option times 100 shares per contract times 10 contracts). If you were to use 30% of additional leverage, then you would own 13 calls instead of 10. But since the delta is 75, 13 call options (which represents 1,300 shares) would be like owning 975 shares, getting you closer to truly owning 1,000 shares. Now, stock has a delta of 1.00. So when we say "10 call options with a delta of 0.75 is like 750 shares," it's because 1,000 shares (represented by 10 call options) multiplied by 0.75 = 750. Thus, 1,300 shares (represented by 13 call options) multiplied by 0.75 = 975. Aaaaaaaand that's why I'm saying 13 call options is like 975 shares. That's why 30% leverage is really no big deal here. As the stock advances, your position's delta will increase and the call option will be more sensitive to the stock's movement. This is a good thing. It will be like owning more and more shares of something that's working in your favor! And as the stock declines, the position’s delta will decrease and the Call option will be less sensitive to the stock's movement. This is actually also a good thing. It will be like owning fewer and fewer shares of something that's NOT working in your favor. (Because we would rather have less risk exposure – that is, fewer shares – of something in decline and going against us).   [Here’s Why to Ignore Steve Martin’s Stock Tips]( [Here’s the EXACT Sector to Put Your Money Into]( [Here’s A Strategy That Beats Powerball](   [YouTube]( [Facebook]( [Twitter]( [Instagram]( [LinkedIn]( DISCLAIMER ©2023 by True Market Insiders, LLC, Protected by copyright laws of the United States and international treaties. This Newsletter may only be used pursuant to the subscription agreement and any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), in whole or in part, is strictly prohibited without the express written permission of: True Market Insiders, 7901 4th St. N STE 6113 St. Petersburg, FL 33702. 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