Why Most Options Traders Are Foolish
The big secret: Where options income really comes from... Why most options traders are foolish... How we can win either way... A completely new source of investment returns that you've never used before...
Today, Doc Eifrig continues his five-part series...
You should take a moment, if you haven't yet, to read the first three Digests I (Doc) wrote on Thursday, Friday, and Monday. These will help you understand what I'm talking about today if you're not already familiar with options.
Today, though, is my favorite installment...
If you follow through today's essay, I promise to show you something about options that you've probably never seen before.
More specifically, I'll show you exactly where options profits come from. Even if you think you know this, I'd like to explain it in a brand-new way. Everyone who reads this should walk away knowing why option investing belongs in your portfolio.
At the same time, I know that most readers won't take the time to learn about options. That's their loss. For the rest of you, please read on...
Let's say a stock is trading for $55 a share and I offer you a chance to buy it for $50 a share right now...
How much would you pay for that call?
You'd pay anything less than $5, right? You could instantly pay $5 for the call, buy the stock at the agreed price of $50, and sell it in the market for $55. Any option price less than $5 would offer an instant, risk-free profit.
We call that $5 price the "intrinsic value" of an option. It's what the option must be worth, given the prevailing prices in the market.
Now, let's change our example slightly...
Let's say the stock currently trades for $45 in the market...
How much would you pay for an option to buy the stock at $50?
In this case, nothing. Even if someone gave you that option for free, you'd take a guaranteed loss if you bought shares for $50 when they trade for $45.
That option should be worthless.
But when you dig into the financial markets, you find out that some traders will pay you real money for these "worthless" options...
Right now, I can find stocks that trade at $45 that have call options with a $50 strike price trading for $2 or more.
That means you can sell something that has no intrinsic value and collect real cash up front today. This is where our options returns come from... and why I've been saying they come from "nowhere."
(And "sell" just means to take one side of a contract. You don't need to own or buy options first to sell them. Tune in to tomorrow's webinar and I'll explain why.)
Now, it's important to explain that these option buyers aren't entirely insane...
There is a reason they'll pay real money for something that's worthless. We just think that in most cases, their reason is foolish.
The option buyer who will pay $2 for a $50 call option on a $45 stock is betting that the stock will rise. More precisely, he must believe the stock will rise to a price higher than $52 in a specific period of time.
Buying the option lets him leverage that bet. He can speculate for less money than if he bought the stock outright.
How much he pays depends on how much time until the option expires...
If his bet ends in June, he may pay $2. If you give him until October, he'll pay around $3.
The more time his bet has to play out, the more he'll pay. That creates an important way for us to make money...
As each day ticks by, the price on the option drops away a little bit. And remember, we sold the option, so we want its price to go down.
So the option buyer pays $2 today for an option that will be worth $1.99 tomorrow... and $1.98 the next day... and $1.90 by next week... and $1.20 by next month. Each day that ticks by, the price of the option ticks down... And that's a profit for us.
Yes, this is true. It's the way that option selling works. We make money as we watch the clock tick. But why is the option buyer doing this? Isn't there a way in which he wins and we lose?
No. If the option buyer wins, we win, too...
You see, in the best-case scenario for the option buyer, the stock shoots up to, say, $55 a share. The option now has an intrinsic value of $5, for which he paid $2. He earns a 150% return on his investment.
We – the option seller – will have to sell our shares to him at $50. But we had a stock that started at $45, collected $2 in options premium, and then sold it for $50. We made $7 per share on a $43 investment, for a return of more than 16%. That's a fantastic win.
But often, the stock will go nowhere – or even fall. In this case, the option buyer will end up with a 100% loss. The calls will expire worthless, and the buyer will lose his entire investment.
On the other hand, we get to keep the $2 free and clear. And we still own our shares... so we can sell another covered call and collect even more income, again and again.
Of course, like all investment strategies, this one still carries some risk. We still own stocks and face a downside if they fall... though we've already seen how this strategy lowers our risk compared with simply buying a stock.
If you're an investor in stocks and bonds, you only get the returns the market gives you...
Your stocks can increase when the company performs well and earnings increase, or when the market rises and the valuation on your holdings increase.
If you hold bonds, you can grow your wealth through the interest payments and broad changes in interest rates.
These certainties underpin our entire financial system. No matter how much time you've spent on your portfolio, that's the basic truth. When stocks go up, your wealth rises. When bonds pay interest, your wealth rises.
Those returns drive the financial well-being for millions of Americans... and billions of people around the world.
With options, you get income from a completely new source.
It's not stock returns. It's not bond returns. It's income from "nowhere." You can create it out of thin air and collect cash flows that simply don't exist for people who won't spend a few minutes learning the basics of options trading.
That's the real story here. In the modern world, nothing carries more value than information.
I'm not trying to give you some squishy line about how "learning is priceless."
I'm talking about real cash profits... And I'm saying that no asset in the world can deliver you better returns and make you richer than the right information and knowledge.
As a Stansberry Research subscriber, you know that you can't get rich investing your salary in cash. Between taxes and inflation, even a high income and a high savings rate won't make you wealthy if your money just sits in a bank account.
You've learned about stocks and bonds, asset allocation, and trailing stops... Those insights have made you better off.
Options can do the same. They are a new source of market-beating returns that can raise you to a new financial class. You're no longer just a "good saver" or a "long-term investor." With options, you can carefully put your assets to work to create intelligent profits from a part of the financial market that few bother to understand.
But even though few take the time to learn how to do it, I believe that anyone can, with just a little bit of effort...
And tomorrow afternoon at 1 p.m. Eastern time, I'll prove it... I'm hosting a free educational webinar to show you exactly how to use this strategy for yourself.
It's not going to be like any webinar we've done before. My research team and I have been preparing for this event for weeks.
Click here to reserve your spot now and get all the details on how you can tune in.
And tomorrow, I'll wrap up my Digest series with an example of an options trade pulled straight from the pages of my most exclusive research service, Retirement Trader. Please don't miss it.
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In today's mailbag, two subscribers are having trouble signing up for tomorrow's free educational event. We hope to see you there... In the meantime, send any last-minute questions to feedback@stansberryresearch.com.
"Good Morning, when I click on the link to register for Doc's webinar, the registration page comes up and then goes dark without my being able to register. Am I doing something wrong here? How am I able to register for the webinar, please? Thank You!" – Paid-up subscriber Robert J.
"When trying to sign up for Doc's webinar I get a shaded screen that is inactive. I cannot click on anything. How do I fix?" – Paid-up subscriber KM
Doc comment: We've received a handful of e-mails from subscribers experiencing similar issues. My tech team tells me it appears to be related to "pop up" blocking software some folks may be using. We've updated our website, so this should no longer be a problem. Simply click here and be sure to sign up for our free VIP reminder service.
Regards,
Dr. David Eifrig, Jr. MD, MBA
Baltimore, Maryland
March 21, 2017