When you talk about options, most people think of risk, dangerous leverage, speculation, or gambling.

And if you don’t know what you’re doing, it may certainly feel that way.

But you see, most people don’t understand options are a way to reduce risk. In fact, options were designed to help investors hedge their portfolios against big market declines.

And today, we may need options more than ever as we face one of the most unpredictable markets we’ve seen in years. If you’re still buying and holding stocks in today’s market, you’re bound to lose money.

But while options can make you a lot of money during hard times like these, you need to understand it’s a process.

If you want to be in the options market for any length of time – and protect what you’ve earned – you’ll have to do it the “right way.”

The “right way” involves a little extra effort. But because I’ve been trading options for over three decades, I can help you master the basics.

Even in the worst markets – like 1987 and 2008 – I had some of my best years ever. During the lead up to Black Monday, I was able to multiply my money 10 times. And in 2008, you could’ve doubled your money on 18 of my recommendations.

For years, I’ve been teaching folks just like you how to reduce risk with options and add a little “pop” to an otherwise conservative portfolio.

Here are three key concepts to keep in mind before getting started…

Truth No. 1: Buying and selling options is about the least risky and potentially most rewarding game on Wall Street.
When used the right way, options are far less risky than trading stocks.

That’s because you risk less money to control a stock in the options market than you do buying the stock outright.

Let’s say you want to buy stock in Company X. It trades for $10 a share. You could put up $1,000 to buy 100 shares.

But you can control the same amount of stock with one option contract. You can buy a contract for, let’s say $50, and leave the other $950 in your account.

If Company X’s stock goes up, you’ll make money. If the stock goes down, the most you’ll ever lose is that $50. That’s a 100% loss, but it’s a lot less than potentially losing 20% or more of the $1,000 you risked buying the stock.

Between 1978 and 1989, this strategy is what allowed options master Victor Sperandeo to rack up an average annual return of almost 71%… without a losing year.

With that track record, we’d be foolish not to pay attention to what he has to say…

Options are, many say, the riskiest game in town. Certainly, they are by far the most challenging, flexible, and potentially profitable financial instruments available.

But if you trade them prudently, if you apply sound principles of money management, trade only when the risk/reward ratio is highly in your favor, and execute your trades with diligence and patience… Then in all likelihood, you will be profitable over the long term.

I can say, conservatively, that at least 40% of all the returns I’ve made in my life have been with options.

Truth No. 2: Want to be a winner? Watch your losers!
To succeed with options, you really need to limit your trading to opportunities that have at least a 3-to-1 payout.

At minimum, you want to have the potential to pocket $3 in return for every dollar you risk. This also forces you to think in terms of reward and risk, which is extremely important.

Most options traders – even ones that may have had good trading systems – fail because they don’t pay enough attention to risk. If you’re willing to lose 50% on a position, you’d better be expecting a gain of at least 150% or more. That’s a tall order.

And if you’re willing to lose it all (meaning the potential for a negative 100% return on a position), then you’d better be expecting a 300% to 500%-plus gain in that position.

When you see it in terms of risk versus reward, and you realize that 500% winners don’t come along every day, you can see how “risking it all” is a bad bet.

Options are a lot like poker – your hand is only a small portion of the battle. Betting appropriately for the entire game is really what’s important, which leads us to…

Truth No. 3: Big winners make small bets.
You’ve got to know when to hold ‘em and when to fold ‘em.

You don’t want to take a total loss with a big bet on the table… So don’t ever put yourself in that situation. Limit the size of your positions.

You should only have 2%-3% of the money you’ve set aside for trading at risk on any one trade. We really can’t imagine any combination of circumstances where you should consider putting more than 10% of your trading money on one play.

Don’t do it!

To end up like Victor Sperandeo over the long run, you’ve got to stick to the program, limit the size of your positions, and limit your downside by never allowing a small loss to turn into a big loss.

Traders who understand these three key truths will have a chance of being winners in options over the long run. Those who don’t will be quickly taken for every penny.

Best regards and good trading,

Jeff Clark

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Source: Jeff Clark Trader