Option Trading Why You Should Never Compound Profits
Below is a MRR and PLR article in category Finance -> subcategory Wealth Building.
Option Trading: Why You Should Avoid Compounding Profits
Summary:
A popular method for long-term investing in stock options is through buying LEAPs call options. These options, which expire six months to a year in the future, allow investors to leverage stock movements with less capital than regular stock trading. However, many traders make a critical error: compounding profits. This strategy, while profitable for stock traders, can be disastrous for option traders due to the leveraged nature of options.
Article:
Investing in LEAPs call options is among the most direct ways to engage in long-term stock option trading. These options, expiring six months to a year ahead, enable investors to leverage stock movements using less capital than regular stock trading requires.
A major pitfall for option traders is the allure of compounding profits?"a strategy popular in traditional investing where profits are reinvested to generate further gains. While compounding has made many stock traders wealthy, it can be detrimental for option traders. The leveraged nature of options can amplify not just profits, but also inevitable losses.
Consider this example:
Suppose XYZ Company’s stock is at $10 on January 1, 2007, and its $10 strike price LEAP call option, expiring in January 2008, costs $2. John invests his entire savings of $1,000 into these options, purchasing five contracts.
By January 2008, XYZ’s stock performs well, reaching $20. The LEAP call options are now worth $18, and John sells them for $9,000, achieving an 800% profit. In contrast, a stock trader would have made only a 100% profit.
Encouraged by this success, John makes a critical error: he reinvests the entire $9,000 into XYZ’s $20 strike price LEAP call options, expiring in January 2009, at $2 per contract, betting on another positive year.
Unfortunately, XYZ’s stock remains almost unchanged, trading at $19 by January 2009. John's options expire worthless, wiping out his entire investment. Meanwhile, a stock trader would have faced only a $1 loss per share.
This example illustrates the dangers of compounding for option traders. Unless you're willing to take significant risks, it's wise to avoid this strategy.
For more insights and free educational resources on option trading, visit [Option Trading Pedia](http://www.optiontradingpedia.com).
You can find the original non-AI version of this article here: Option Trading Why You Should Never Compound Profits.
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