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Stock Replacement Options Trading Strategy

Filed Under Advanced Options Trading 

Stock Replacement
 
If you are a stock trader, thinking about getting involved in options, stock replacement strategies will make a lot of sense. If an investor thinks that they want to make money on a stock within a time frame of a month to three years, it makes indisputable sense to use stock options. The reason: if done properly with stock options, the same results can be purchased for about 15%-20% of the capital required to buy the stocks themselves, which means a tremendous boost in Return on Investment (ROI). Or, an investor can have the benefits of owning many times as much stock for the same amount of capital. Moreover, to put the icing on the cake, when owning stock, the investor may face unknown significant losses in value whereas stock options have a known maximum loss.
 
So, according to Option University’s Stock Option Mastery Course, “for a stock trader and someone who is very good at picking stocks, using a stock replacement strategy using stock options can be a very easy, safe, cost efficient way to reduce risk, increase profits and obtain a much higher return on investment. It’s as simple as that”.
 
Stock replacement strategy combines the exact same philosophy and analysis that a stock trader uses to find opportunities but is just a different way of executing that opportunity. As a stock trader, you do your analysis and decision making in the same fashion but it is the last step in acquisition that changes when using options to replace stock. Instead of purchasing the stock, you will purchase a call option (if you would be long the stock).
 
In the stock replacement strategy, a trader wants to accomplish the same thing as if they own the stock and we want the option to act just like the stock. If the stock moves up $1, we want the option to also move up $1. The key to the stock option strategy is to purchase an option contract (100 shares) with a Delta very close to 100 Deltas for the contract (close to one Delta per share). That means that the option will closely mimic the movement of the underlying stock.
 
Let’s use an example taken from the Options University Mastery Classes. Say you were going to buy an $80 stock because you thought it was going to run up $10 and let’s say you were right. You bought the stock for $80 and it ran up to $90. You’ve got a $10 return on an $80 investment, 12.5% return; nice job. 
 
What if you can replace that stock with an option that costs only 25% of the stock price but mimics the stock movement to 80%? Hence, you have an 80 Delta, $80 option. So now when the stock runs up $10 your $80 option (purchased for $20) is going to mimic that stock’s movement to about 80%. If the stock runs up $10 your option that you spent $20 for is going to increase by $8 (80% of the stock movement); that’s what an 80 Delta does.
 
You now have an $8 return on a $20 investment and that’s a 40% return on capital invested and that’s a lot better than the 12.5% return when the stock was purchased outright. You only had to put up $20 freeing up another $60 to do something else or you could have invested a little bigger. Either way, you have a much better return for much less capital.  
 
But why pay such a high price for an option when there are much cheaper options? The answer is simple and important. To replace, or closely mimic the movement of the underlying stock, you need to buy an in-the-money option; the higher the Delta, the higher the correlation to the underlying stock. Not only that, for an option to have any value, it needs to be in-the-money before expiration. If it’s out-of-the-money at expiration, the value of the option will be exactly zero.
 
 

For information on all things stock option, go to www.optionsuniversity.com

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