Chris Rowe

   

RULE NO. 2: WHEN BUYING OPTIONS, KEEP THE CASH YOU SAVE

What do you do with the remaining $16,500 out of the $20,000 that you would have used to cover your short stock? (Remember, we only used $3,500 on five put contracts at $7.)

LEAVE IT IN CASH! Consider it part of this trade … the capital that is impossible to lose (which is pretty much the case). Reserve it for when you want to trade stock again. Don't use the remainder, not even to buy other options.

Remember that you are being conservative here. What I've just suggested that you do with this one position is what you should do with each position that you play when you replace stock with options.

So what is the benefit of replacing stock with options? The benefit is simple.

Normally when you sell a stock short, you have unlimited risk. The mere fact that there is so much risk involved tends to steer investors away, keeping them from profiting from a down market.

So at this point, you may be thinking to yourself, "If I did sell a stock short, couldn't I just limit my downside by implementing a stop-loss (an agreement to close out a position -- in this case, to buy the stock back -- at a pre-determined price) with my broker?"

You could, but there are two problems with that line of thinking:

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