Is the dollar amount at risk more or less critical than the percentage amount to increase wealth?
The article "Recapture Lost Profits With This Easy Options Strategy" does not evaluate on basis of % gain/loss, but only considers the $ amounts.
Answers
2183 points
ChaosNantuko answered 7 months ago …
Dollar amount at risk should be based on % of portfolio, and based on where you put your stop loss.
EG if you buy a $50 stock, with a stop loss of 45, your risking $5 per share. A good rule for most is that you should only risk 2-3% of your account on a single trade. If you have a $50000 account, 2% is $1000, so risking $5 per share, you should purchase 200 shares.
If using leaps to substitute for shares, it depends on your stop loss. With no stop loss, buying $1000 worth of leaps would work to stick to the risk management scheme. If you do have a stop loss, at perhaps 50%, then 1500 worth of leaps is more appropriate (options can gap dramatically, so including room for error).
When using leaps as a substitute for shares, the $ risked/$ gained is more important.
When comparing investments, the % possible gain and % possible loss is more important, because the size of the investment can then (usually) be scaled.
237 points
josephconlin answered 7 months ago …
I think the purpose of the article was to point out that you can make more total dollars and lose less total dollars by using options while ALSO risking fewer total dollars. Since the percentage of your gain or loss is gain(loss) divided by amount risked, it stands to reason that the percentage gain and loss will be larger for the options than the stock because the amount risked is lower in the option case.
In the limited space available in the article, and with previous articles by the author on this very subject being available in the archives of www.thetycoonreport.com, I believe that the author may have thought that showing the percentages might have made the point of the article less clear, and that those who wanted more information could reference the other articles he has written on this topic.
We can easily compute the percentage gains and losses from the examples given in the article. Here's one example.
From the RIMM example in the article with a 10 point gain:
Option - $10,550 / $28,600 = 36.8%
Stock - $10,000 / $64,000 = 15.6%
Now the RIMM example with a 10 point loss:
Option - -$9,360 / $28,600 = -32.7%
Stock - -$10,000 / $64,000 = -15.6%
The percentage of gain and loss with the option is higher because the amount risked is substantially lower than with the stock, while the amount of the gain or loss is relatively similar for both. However, less risk is a good thing, and you still get better overall dollar returns. The article also doesn't point out the interest you gain on the $35,400 that was recommended to be put into a cash account as part of the trade to make the option position total $64,000. Depending on the length of the trade and the interest rate, that interest might only be $50 or less, but it's extra upside to the option strategy.
In the end, the percentages are nice to know, but they can muddy the water a little when the point that is trying to be made is that, with the exact same $64,000 total, you can put yourself in a position to make more total money if it goes right, and lose less total money if it goes wrong, by using options wisely instead of stock.
One last group of percentages, and then I'm done.
The options gain of $10,550 is 5.5% better than the stock gain of $10,000 ( [$10,550 - $10,000] / $10,000).
The options loss of -$9,360 is 6.4% better than the stock loss of -$10,000 ([-$10,000 - -$9360] / -$10,000).
The amount of money risked with options of $28,600 is 44.6% of the $64,000 risked with stock ($28,600 / $64,000).
