One Advantage of Options: Less Exposure

The Benefits of Leverage

My Track Record

Keeping Risk Low

My first article for Cabot Wealth Advisory appeared back on December 27, 2010. As the editor of Cabot Options Trader, I intended to educate subscribers about options–perhaps dispel a few myths and point out some of the advantages of options.

One of the main appeals of options is that they provide the investor with leverage. A move of 5% to 10% on the underlying stock can easily generate a gain (or loss) of 80% to 100% on an option. And options allow investors to participate in the market with a smaller cash outlay. Here is what I wrote:

“Options give you the ability to be involved in opportunities at a much lower cost than investing in shares of the stock. Thanks to the leverage that options provide, you can make almost as much money as you would on the stock but with a significantly lower investment amount.”

Because of the volatility and the sell-off we’ve experienced in stocks recently, I thought now might be a good time to take a look at the track record for the Cabot Options Trader since the market peaked on May 2.

The following table shows every Cabot Options Trader recommendation that was opened and closed from May 1 through August 18. During this time, the overall return for the portfolio was 24.3%. Now you might guess that we had recommended a ton of puts and taken advantage of the downswing. But in actuality, there were nine recommendations with six calls and three puts.

Table 8//images/table-082911.jpg

(Click here to view the table at a larger size.)

While I am very pleased with these results, that is not the main point that I want to make here. The main point is the way you can keep risk low while trading options. In this case, there were 76 trading days since the May 2 high and August 18. The most recommendations we had open at any given time during this period was three. This means that no more than 60% of the portfolio was exposed at any time while the other 40% was sitting in cash.

Let me explain this concept a little further. With Cabot Options Trader, we suggest that no more than 20% of your portfolio be put into any one trade. With three positions open at one time, 60% of your money would be divided among the three open positions while the other 40% of the portfolio would be sitting in cash.

Meanwhile, of the 76 trading days referenced earlier, there were only seven days where three recommendations were open. This means that 90% of the time, more than half the portfolio was in cash and yet it was still able to grow by 24%.

Are options riskier than stocks? On an individual basis, yes they are. However, during volatile times like we have seen over the last three-and-a-half months, options can be very useful by allowing you to keep a good chunk of your portfolio in cash while using smaller trade allocations to take advantage of the swings.

So the next time someone tells you that options are risky, keep in mind what you have learned in this article. Sure options are inherently more risky, but they let you participate in the market movements with less money exposed to overall market risk.

Good luck and good investing,

Rick Pendergraft
Editor of Cabot Options Trader

P.S. Don’t let the market’s volatility keep you out of investing. Use Rick Pendergraft’s Cabot Options Trader recommendations to make money in all markets … with less risk! Instead of missing out on winning trades, he uses the market’s volatility to his advantage and profits when most investors sit on the sidelines. Try a risk-free trial today!

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