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Types of Risk
Without Some Risk, There Can Be No Gain
Overestimating risks and avoiding losses is a fine strategy for surviving dangerous environments, but not for thriving in a modern career.
When risks aren't life threatening, you have to overcome your brain's disposition to avoid survivable risks. In fact, if you are not actively seeking and creating opportunities--which always contain an element of risk--you are actually exposing yourself to more serious risks in the long term.
Another Way of Saying the Above:
THE GREATEST RISK IS TAKING NO RISK AT ALL
Types of Risk
Risk itself is the possibility of loss.
Most intelligent people realize that the amount of risk one takes in the markets (and in life for that matter) is in direct proportion to how much one wants to achieve or profit.
Blind Risk:
Also known as the desire of something for nothing, laziness and irrational hope.
It’s a pointless gamble, an emotional decision as well as a sucker play – a roll of the dice –
a toss of a coin.
It can be compared to a drunk walking a tightrope
Calculated Risk:
To use one’s mind to visualize possibilities, to work things out logically – to reach a conclusion - and then to act with strength and confidence – that’s what makes the human mind superior to all other species that dwell on this planet.
Calculated Risk lies at the center of every great achievement since the dawn of time.
It builds nations and empires as well as financial fortunes.
The art of determining an existing price trend and to be able to follow it using Calculated Risk is what, over time, amasses incredible profits in the markets.
No one – no one – knows what will happen in the future and once you fully realize and appreciate this fact – it’s like a huge weight is taken off your shoulders.
There are no guru’s, no Holy Grails, no guarantees - however the ability to spot developing price trends in the markets (stock, bond, commodity and currency markets) and to get on board and ride it for everything it’s worth (until it eventually ends), is what creates untold fortunes.
When you own a stock, commodity, currency, etc. OPTION, you are only risking the premium you have paid for that OPTION (plus the commission).
This is known as LIMITED RISK and is crucial to successful long term trading and investing.
Limited Risk & Option Trading
The Difference Between Call Options & Put Options
Call options give the buyer the option to buy the stock, commodity, currency, etc. at a predetermined price (the strike price).
Put options give the buyer the option to sell the stock, commodity, currency, etc. at a predetermined price (the strike price).
The option itself is not the risk, nor is the loss the risk – the possibility of loss is the risk.
When you purchase a stock, aiming for profit, risk is fundamentally unavoidable and the best the trader or investor can do is to manage the risk.
Theoretically, when you buy a stock, it can possibly go to zero / the company can go bankrupt, etc. and you will lose your entire investment.
When you purchase an option however, you are also aiming for profit, but the very most you could possibly lose (again, if the company goes under, etc.) is the premium you paid for that option plus commission.
The only difference is that with options, you are fighting the clock (they are called decaying assets), however, you have the huge advantage of incredible leverage when purchasing options.
Here’s how it works:
An investor purchases 100 shares of ABC Corporation which is trading at $10/share at the time of purchase. The investment / total risk is $1,000 (plus commission).
If ABC Corporation’s stock goes “bust”, the investor loses $1,000 (plus commission).
If ABC Corporation’s stock increases by 30% (hypothetical), to $13/share, the investor has made a profit of $3/share or $300.00 (a 30% profit).
If ABC Corporation’s stock does nothing / goes sideways, your open profit and loss will fluctuate along with the stock’s price.
Now, let’s look at buying a call option on ABC Corporation:
ABC Corporation is trading at $10/share at the time of purchase.
A trader (or investor) purchases a call option in early January and it expires in mid-March.
The premium for the one call option is $150 (plus commission) and the option’s selected strike price is $10/share.
One option contract controls 100 shares of ABC Corporation – that is, the trader is not buying the actual shares, but instead controlling the right (not obligation) to buy those 100 shares at $10/share (your selected strike price) no matter what the underlying stock prices moves to.
In order to profit, the share price has to move up (with a call option) before the expiration date in mid-March.
If ABC Corporation’s stock goes “bust”, you lose your $150 premium plus commission.
If ABC Corporation’s stock increases by 30% (hypothetical), to $13/share, the trader has made $300.00 (the stock moved 30%, but you made a 200% profit)!!!
That’s known as leverage.
Essentially, LEVERAGE involves "putting up" / investing very little money in order to CONTROL large amounts of an asset (stocks, commodities, currencies, etc.), yet having the potential of making very large profits (as if you had invested the full amount to OWN the asset).
IF ABC Corporation’s stock does nothing / goes sideways, or goes down in value, and you don’t sell for a loss before mid-March (expiration date), you will lose your $150 premium (plus commission) - that is, your call option on ABC Corporation will expire worthless.
Bottom Line:
Buying the actual stock for $1,000 with a 30% move in the stock price – you make a 30% profit.
Buying a call option for only $150 with a 30% move in the stock price – you make a 200% profit!
That is also known as a 200% ROI / Return On Investment – you invested $150 and made $300 (you now have $450 in your account).
That’s called LEVERAGE – and that’s how experienced traders become wealthy in the markets – with options.
The above example is illustrating the purchase of 1 option – imagine purchasing 10, 20, 30 or more options – the profits become mind boggling!!!
You can also utilize put options to profit in the same way when a stock, commodity, currency, etc. goes down / decreases in price!
Emotionally, knowing that the most you could possibly lose is what you paid for the option(s), makes for far fewer traders with ulcers – especially in very volatile markets (like the oil market as of late).
In Addition:
Asymmetric Leverage must always be employed.
Asymmetric Leverage is the attempt to profit from the potential upside of leveraged trading with very limited downside risk -- that's the key to trading longevity!
This is also why Trader Screen utilizes options on:
-Stocks (US & International)
-Bonds
-Commodities
-Currencies (US & International)
-Exchange Traded Funds (ETFs)
In order to:
-LIMIT RISK *
-MAKE HUGE GAINS (a.k.a. – Return on Investment / ROI’s).
*For details on Risk Management, simply order:
Trader Screen Stock & Commodity Overview Report