Cut Investment Risk 50% With Smart Option Strategy

May 25, 2011 - PRLog -- Most people think options are for speculators. They couldn't be more wrong. Options are there to cut risk. That's what the pros call "hedging." Smart option strategy lets investors keep all the profit potential of buying stock with much of the risk removed. Interested?

Stock Replacement Strategy
The Stock Replacement Strategy is a great example of safe money option strategy. Instead of buying shares of stock, buy deep-in-the-money call options. Don't get scared! This is simpler than it sounds.

The best way to explain is with an example. Let's use a stock called “ZZZ.”
ZZZ is selling for $145 a share. 100 shares would cost $14,500, plus commissions. That's a lot of money for most people.
* Instead of expensive stock, buy ZZZ July $95 Call options.
* One such Call option might cost $7,695.
* That's only 53% of the cost of 100 shares of stock!
* These Call options give their owners the right to buy 100 shares of ZZZ for $95.00 per share any time until July, 2011.

Options
Options give buyers the right to buy or sell stock, not the stock itself.
* "Deep-in-the-money" Calls give the right to buy stock for much less than its current price.
* Cut risk by almost 50% by replacing the stock with the option.
* Deep-in-the-money Calls go up almost dollar for dollar with the stock. That's why they can replace stock in a portfolio.

Advantages
Let's look at the advantages -
* Risk only about half the money.
* Diversify. What’s saved on one stock can be invested elsewhere. That also cuts risk.
* Don't just buy two Calls with the same money that might have been spent on stock. That risks as much money without diversifying.
* Percent return is almost doubled.
* If ZZZ goes up $10, make $1,000 on the $14,500 stock investment, a 6.9% profit.
* But if ZZZ goes up $10, make $980 on the $7,695 Call investment, a 12.7% profit.
* If ZZZ goes down $10, the percentage returns would be the same - in the opposite direction.

What if ZZZ takes a big fall? Suppose some horrible surprise causes the stock to fall from $145 to $100? That's most investors' nightmare.
* The loss on 100 shares of ZZZ stock would be $4,500.00.
* The loss on one July, $95.00 Call would be $4,410.
* The maximum possible loss with the stock is $14,500.
* The maximum possible loss with the call is $7,695.00.
Risk is not eliminated, but it sure is cut.

Tips
Here are two tips for using the Stock Replacement Strategy -
* Always buy Calls with at least three months until they expire. That gives them time to rise. (Unlike stock, options have an expiration date, so allow enough time to profit.)
* Options lose value fast in their last month, so them before then.

Find out more about option strategy at http://safemoneyproducts.com/option-strategy. Subscribe now at http://safemoneyproducts.com/subscribe/ to get 4 Free Reports and bi-monthly Action Alerts.

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Safe Money Products, written by Dr. Bob Rubin, is a financial newsletter. Bob’s investment philosophy is to buy assets with both strong growth potential and limited risk. Bob researches both commonplace and little known investment opportunities. Visit http://safemoneyproducts.com for more information.