How To Turn A 12% Stock Move Into A 133% Gain
Risk and reward tend to go hand-in-hand. So anything that involves the potential to increase your returns more than 10-fold must be extraordinarily risky and volatile. Like scoping out a nano-tech software developer in Eastern Europe or speculating on a South American foreign currency futures contract.
That’s not necessarily the case, however. So let me put you at ease…
There is a proven way to magnify your returns that is far less exotic. You can even utilize this tactic with reliable, blue-chip stocks trading right in your own backyard. The secret has nothing to do with which securities you buy – but how you buy them.
I’m talking about stock options. If you’ve never dealt with options before, don’t worry. I know what you’re probably thinking. But first, I want to start with a simple example.
The Power Of Leverage
Imagine there’s a guy (we’ll call him Steve) who is about to become a first-time homeowner. Steve has just signed the papers and picked up the keys to a $300,000 home. It’s a nice neighborhood, where real estate values have generally appreciated over time. Five years later, the house appraises for $330,000.
Steve decides to sell, pocketing a tidy gain of $30,000 (let’s not worry about realtor commissions). Compared to the value of the home, that’s a return of 10% ($30,000/$300,000).
But here’s the thing… Steve didn’t pay the entire mortgage upfront. He only made a 20% down payment, handing the lender $60,000.
So relative to his $60,000 investment, the $30,000 profit actually represents a gain of 50%. His outlay was five times smaller, so the return was five times larger.
That’s the power of leverage: using a modest amount of money to control a larger amount.
“Leverage” is often seen as a dirty word when it comes to investing. But if you can understand this analogy, then you’re halfway to understanding how that isn’t always the case. And how options can be a powerful tool to grow your portfolio.
As we all know, stocks are constantly pinging around every minute of every trading day. By harnessing the power of options, you can take full advantage of those price swings. Just like Steve did in our example, options will allow you to fully participate in stock movements, while only putting up a small fraction of the underlying asset value – thus magnifying your returns.
It’s like putting up a small ante to win a huge pot.
Is that risky? Not necessarily. While any investment involves the potential loss of capital, options aren’t inherently risky. In fact, they can be used to minimize losses. They can also generate predictable income while safeguarding against market volatility.
Let’s take call options for example. In the following example, I’m going to show you how a simple price move can be amplified into a much bigger gain using the power of leverage.
Here’s How It Works…
Let’s look at a real-life example using a household name. Wal-Mart (NYSE: WMT). Shares of the retail giant are currently trading at $130 as I’m writing this. There is a call option expiring September 25 with a strike price of $135 and a premium of around $3. Remember, each contract controls 100 shares, so the total cost for the option would be $300.
Suppose Wal-Mart stuck stays flat or declines between now and the expiration date. In that case, there would be no point in buying a stock from the seller for an above-market price of $135. Therefore, the option would expire worthless.
So even if WMT stays unchanged, you would lose $500. That’s the trade-off for a much richer potential payday.
The break-even point on this contract would be $138. You would gain $3 per share ($138 minus $135) for 100 shares, offsetting the $3 premium. Anything above that level would be profit. Let’s suppose WMT shares climb to $145.
At that point, you could exercise the option, buying 100 shares at $135 and then promptly selling them in the market at $145, collecting a gain of $1,000. After subtracting the $300 premium, that would leave a net profit of $700.
In percentage terms, that’s a hefty return of 133% ($700/$300). Alternately, instead of exercising and taking control of the stock, you could simply sell the option back. Either way, the call option made the most out of WMT’s rally.
Had you just bought the stock outright, it would have cost you $13,500 upfront (100 shares * $135). And the gain would have been much smaller, just 12% ($145/$130).
Action To Take
Keep in mind, this is a rather straightforward example. And it’s purely for illustrative purposes and is not meant to be taken as a trade recommendation.
The point is, some options trades are meant to profit from an expected downward move in a stock. Others are designed to generate income if the stock moves sideways. There are even complicated strategies involving two or more options contracts working in tandem.
I’ll leave those strategies for other more qualified experts. We stick to using simple call options on the targets identified by my Project Rainmaker system. And for several months now, we’ve made some remarkable gains in a short period of time…
– 46.4% in less than 3 months from an energy stock
– 65% in less than 2 months from an online travel stock
– 88% in a month from a logistics firm
– as well as gains of 150%, 170%, and even 343%.
Now, Project Rainmaker isn’t an options trading system. It’s simply meant to identify picks for regular investors like you and me. But my team and I also regularly offer trades like this for our readers to be able to fully take advantage of the power of leverage.