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The world of options opens up a number of techniques that can be implemented in order to increase your rate of return as well as mitigate risk. There are endless hedging possibilities and new strategies are being developed all the time. Through my experiences with option trading, I have tried almost every strategy that I could find. In this book, I will be discussing the strategies that I use the most and feel are the best available. I will take you through a number of actual trades as they occurred and show you what I did right and what I did wrong. I will also show you plenty of theoretical examples of how the strategies work and what factors will influence which strategy is the best for whatever situation the market throws in front of you.
Initially, before trading options, I was a "stock only" trader who was just curious about alternative investment products. I had often heard stock options mentioned, usually in the form of Employee Stock Options. I began to learn as much as I could about option trading and testing the strategies as I learned them. In 2007 I was the first place finisher in the Zacks.com 4th Quarter 2007 options trading contest with a return of 212%. I currently trade options as a speculative tool as well as a way to hedge my risks on the individual stocks that I own. It hasn't always been pretty but I have used both my gains and my losses to learn, both of which I'll be discussing with you. Often options get a bad reputation from the potential losses that can occur from owning options as well as selling what are called "naked" puts and calls. These topics will be covered in detail later but the important thing to remember is that the less you know about an investment the more risk you are tackling. Any investment product in the market can potentially cause large losses if the investor does not fully understand the risk he or she is taking on.
Once you gain some familiarity with options, I would advise you to paper trade option strategies for at least six months. Paper trading is a valuable tool; it will get you involved in the market and allow you to start following the individual stocks that you will be trading the options of. As with any investment tool, options may not be for everyone. The potential for large losses is real and should be evaluated. I would also advise any investor to use no more than 5% of their available investment portfolio in options. This is because many of the option strategies are considered speculative. As with any investment, if there are large gains to be made there are also large losses to be had.
Even with the dangers in mind, I will show you how to calculate your risks ahead of time. What investors often fail to understand about options is that, if correctly implemented, options can, in fact, carry less risk than some stock. There are plenty of option strategies that are specifically tailored to lower an investor's risk profile. Options can be used to generate income and can be used as a form of insurance against the stocks that you own in your portfolio.