Chris Rowe

Why You Should Never Trade a Stock or ETF Again

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I chose to use this example because the option was actually in the money, and I'm telling you to buy options that are in-the-money. But the option above wasn't deep enough in the money. Said differently, it didn't have a high enough delta. The delta was probably about 0.55. It was only one strike price in the money. 

Time is Always Working Against You

Today we continue to learn the concept of trading options with a higher delta (that is deeper in the money), so I'm not talking about the calculation or what the deltas of the options actually are. Soon, I will show you how to find the EXACT option to buy, and what the deltas of those options are. 

In the previous above, what happened to me, in real life, was I bought the option when there were three months left. Rookie mistake.

The option started out at $3 in my case. I knew that since it was $1.50 in-the-money (it had $1.50 intrinsic value and another $1.50 of extrinsic value (time value), at least half of the price ($1.50) wouldn't be affected by time decay. 

What happened to me was the stock actually traded a bit higher (by about $1, if memory serves) and I still lost money. This happened because, although the stock gained $1, I lost the $1.50 in time value. So I lost 50 cents. Time was working against me.

Had the stock traded down by $1.50, since I waited until expiration day, I would have lost $3 (twice as much as the stockholder would have lost). 

So the stock had to trade more than $1.50 higher for me to just break even, or $1.50 lower for me to lose everything. And boy did I over-leverage. My stomach hurts just thinking about it. 

With odds working against me like that, I shouldn't have committed so much to the trade. In fact, with those odds, I shouldn't have even committed $1 to the trade.

Are those the kind of odds you want to work with? NO! 

We want to increase our potential reward, and we want to significantly reduce our risk. Because when we are wrong, which tends to happen, we are left with a heck of a lot more money that we can use to make nice profits when we are right. We don't want to end up feeling like we should now risk a larger percentage of our investment capital just to make back what we lost on the last trade!

One last note on how to avoid over-leveraging before. Your broker will absolutely HATE this idea because they want you to invest (risk) as much money as possible, but I happen to like the idea of you trying to get yourself paid. You don't have to commit as much to the trades/investments any more.

Keep lots of cash on the sidelines and consider it as part of the trade. You can use leverage, but just a little bit. Assuming you would have felt comfortable buying 500 shares of a $20 stock (a $10,000 trade/investment), then what you should do, instead, is buy five or perhaps six call option contracts, which would represent 500 or 600 shares of the stock. 

Buying that extra call option (six instead of five) is FINE and will usually amount to the same risk and same reward that a stock trader with 500 shares would have if there is a 1-point move in the stock ... as long as you buy the right option.