Take Risk Off the Table Without Jeopardizing Your Returns

Karim Rahemtulla By Karim Rahemtulla
Options Strategist, The Oxford Club

Alternative Income

Is the market overvalued?

Yes. By many measures, this is one of the most overvalued markets in history. Price-to-earnings and earnings growth are two measures that should tell you this 9-year-old bull market is closer to the top than the bottom.

Volatility, as measured by the Volatility Index or VIX, is showing complacency associated with market tops.

But thanks to a unique and simple strategy, you can take more than 85% of risk off the table and still not give up an ounce of upside.

Think about that: You can pull 85% of your cash out of the market but still retain the same exposure you had before.

Most investors use a stop loss of some type. At The Oxford Club, we usually recommend a stop loss of 25%. With this strategy, your upside is unlimited, but you could lose a full quarter of your investment.

LEAPS Options: Even Safer Than Trailing Stops

With a class of options called LEAPS, you can mitigate substantial amounts of risk while still enjoying unlimited upside.

LEAPS stands for Long-Term Equity Anticipation Securities. These are options that you can buy in any account, including your retirement account. They allow you to control the underlying shares for periods of up to three years.

When you consider that most investors today don’t hold stocks for more than a few months, three years is really an eternity.

These LEAPS are usually available on most established midcap or large cap stocks on the Nasdaq and New York Stock Exchange. You’ll find them on companies like Apple (Nasdaq: AAPL), NVIDIA (Nasdaq: NVDA), Merck (NYSE: MRK), Barrick Gold (NYSE: ABX). You won’t find them on small cap stocks.

Let’s say you own 1,000 shares of Apple, for example. You are risking $154,000 in the market for your position. You think Apple will go to $220 in the next two years. That would be a fat return. But your 25% trailing stop means you’re willing to lose up to $38,500 if you’re wrong.

Let’s look at how a LEAPS option would work in this situation. You can buy a LEAPS that expires in 840 days (more than two years) that allows you to own Apple at $155. That option would cost you about $23 per contract. For a trade that allows you to control 1,000 shares, your cost would be $23,000.

So right off the bat you stand to lose less than your 25% stop loss. In fact, the MOST you can lose on this trade is what you invested. Twenty-three thousand dollars is 14.9% of the $154,000 you have at risk for owning Apple shares outright. So you’ve just yanked 85% of your cash and risk off the table.

If Apple hits your $220 target, you would be up $66,000, or 42%. Your LEAPS option would be worth $65 ($220 minus the $155 strike price). You must subtract another $23 for your cost, so your net return would be $42,000 ($65,000 minus $42,000).

You’ve almost doubled your money! Sure, your actual dollar return is less than it would be with a regular stock trade… but you have 85% less at risk!

Right now, with volatility being so low, you can control 1,000 shares of a gold stock like Barrick Gold for less than $3,000. This is the right time to use LEAPS, as the market is in nosebleed territory and low volatility allows you to buy call options cheap.

The great thing about LEAPS is that even if the market corrects, you’ll still have time on your side. After all, 840 days is a long time – more than enough time for the market to correct and then resume its upward trend.

And even if it doesn’t, your risk is still limited to what you paid for the option. If the market screams higher, you know that you won’t miss out on that move. But you also know that you have the bulk of your cash squirreled away as well. That makes for a very good night’s sleep!

In my Automatic Trading Millionaire service, we use short-term options and LEAPS in unique ways to generate income with significant downside protection. You can find out how by clicking here.

Good investing,

Karim