Larry’s Note: Today is the final day to catch my AI Chaos to Cash replay. If you haven’t yet learned my strategy for profiting amid the market’s chaotic swings, don’t miss your chance. At this event, I shared how you can enter a trade in the morning… and potentially have hundreds or thousands of dollars in your pocket by 4 p.m. ET. Watch here now while it’s still online.
Sometimes you’ll hear a trader talk about a “high-conviction” trade. It reflects their confidence in an anticipated move playing out.
Perhaps they’ve researched a stock’s valuation, growth, and financial prospects. Beyond that, the broader macroeconomic picture stacks up and supports their trade thesis.
There could be a promising setup on the chart, with evidence that buying momentum is building. Technical indicators support an imminent move.
But this is where traders can run into trouble. You need to consider the trade’s potential payoff. If you don’t, that mistake can cost you a lot of money…
You can have a high degree of confidence in a stock but still make a bad trade. That’s because your risk-reward profile can be out of whack.
For example, you might buy a stock after bullish news. The stock rallies, and momentum surges. You feel confident that the up move is just beginning.
But you could be overpaying and risking a bigger loss than your potential reward. In this example, other stockholders could use the surge as an opportunity to bank profits – and that wave of selling can hit the stock hard.
Just look at Micron (MU). It reported stellar earnings on March 18, and the stock was starting to move to new highs. Then MU sharply reversed and is now down 29% in less than two weeks.
That’s why the risk-reward picture is so crucial. Alongside a high level of confidence, you want to ensure that your potential reward exceeds the risks.
The goal is to enter an “asymmetrical” trade – meaning that you stand to gain far more than you could lose. That’s where options fit into the picture…
One reason options can be so useful is that your risk is clearly defined.
If I buy an option, the most I can lose is the premium I paid. In the case of a call option, my upside is uncapped. (With a put option, a stock can only fall to zero.)
Options are also far cheaper than buying the underlying stock outright. I often look to buy options around the $3 level, which equates to $300 per contract (an option contract is for 100 shares). If I bought 100 shares outright, the trade could require thousands of dollars upfront.
So if I trade options, I have a lot more flexibility in how I deploy my capital.
And if an options trade goes my way, I can easily make double- or triple-digit gains. Options have leverage, which means a 2% or 3% move in the underlying stock can translate into a much bigger gain. That can be really powerful when markets are swinging all over the place.
To be clear, not all option trades are good trades. You can still overpay for options or choose a strike price and expiration that doesn’t pay off.
But if you can combine high conviction and a strong risk-reward profile, you put the odds far more in your favor. And in chaotic markets like we’re seeing now, options are one of the best tools in your trader’s toolbelt.
Happy Trading,
Larry Benedict
Editor, Trading With Larry Benedict
Reading Trading With Larry Benedict will allow you to take a look into the mind of one of the market’s greatest traders. You’ll be able to recognize and take advantage of trends in the market in no time.
