We would like every trade to be a winner, but sometimes even a good trade can go bad. We are going to go back and look at a trade and see where it went wrong. We will then figure out a strategy on how to fix this trade.
Options were originally created to hedge or avoid risk. By purchasing or selling options, you can custom tailor the profit and loss profile of your holdings which is something that long stock holders cannot do.
While there are numerous advantages to options, most can be grouped into one of three
categories. First, significantly less money is spent to gain control of stock. Second,
investors can alter the profit and loss profiles to accept or reject particular risks. Third,
investors can profit from a lack of movement in the stock, which is certainly something
that cannot be done with stock ownership. Let's take a closer look at each of these
reasons in turn.
Over the past few months, I've presented some hedging ideas and strategies for retail investors. Many of the questions I receive have a similar tone where people ask things like, "Wouldn't it be better to buy the $50 call instead of the $55?" or "Wouldn't it be better to sell a higher strike put so that you get a bigger credit?" While these are great questions, there is one simple way to answer them all decisively — by understanding the elusive concept of risk versus reward.