The Key to Success With Options

August 25, 2023

To many, options are the final frontier of the financial world.

They’re the wild west of investing.

They represent opportunity and freedom… but they can be rough on the uninitiated.

The key to surviving in America’s Wild West wasn’t having a single skill. It was having many skills and many tools to choose from.

The uncalloused hands of a city slicker weren’t of much use if they couldn’t swing a hammer or drive a mule.

It was the fella who could do it all who survived while following the setting sun toward new hopes and dreams.

Modern investors must have the same mindset.

Yes, we can get by just owning exchange-traded funds. And yes, we can survive with a “set it and forget it” portfolio of blue chips.

But is survival really what you’re looking for?

Did folks in frontier times really give up life in the East just to survive in the West?

Unlimited Potential

Look, some of the biggest and fastest gains of my career came from stocks alone.

For example, in February 2020, I spotted some unusual volume activity from vaccine maker Novavax (NVAX). When I first wrote about it, the stock was trading for less than $8. It hit a high of $290 a year later.

At that peak, it was a 3,500% gain.

But let’s be clear… Investing in small biotechs – or any other penny stock – comes with nearly as much risk as investing in options.

They can both go to zero.

But what options can do that small, speculative stocks can’t is hedge a position, give us a way to play a downside move and allow us to leverage a small amount of money for a large potential gain.

And yet… most folks I talk to aren’t intimidated by penny stocks in the same way they are intimidated by options. In fact, they’re excited to jump into penny stocks and eager to get their hands on a fresh stream of ticker symbols.

Meanwhile, they’re flat-out scared of options.

I say it’s because options come with a vocabulary of their own – strike price, expiration, implied volatility… and, dare we say it, the “Greeks.”

There’s a lot to learn.

Manward can help with that.

But there’s something we can’t help with. And it’s the absolute key to investing in options – smart position sizing.

The Goldilocks Trade

Flat-out… too many folks put too much money into options.

We hear about it all the time.

They’ve got five grand in their trading account… and instead of investing in stocks, they bet it all on the allure of fast-moving options.

That’s silly.

Think of it this way. We typically use a 25% trailing stop on our stock plays. That means – given normal circumstances – the most we can lose on a play is 25% of our initial stake.

With options, though, it’s quite possible to lose 100% of your entry stake. It happens a lot.

That’s why you should never put more than 25% of what you’re willing to invest in the underlying stock at risk in options.

In other words, if you’re looking to invest $4,000 in shares of XYZ… you should invest no more than $1,000 in its options.

That way, if your investment tanks, you’ll be out no more than the $1,000 you would have lost if XYZ had dropped by 25%.

You’ll still have $3,000 in your account… and you’ll still get in on all the upside fun if XYZ takes off.

Master this idea, and you’ll be well on your way to successfully trading options.

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