| | | | We can see that evident in the S&P, Dow Jones, and Nasdaq Composite in the chart above.
So if every day, historically speaking, the markets have a higher chance of going up than they do going down… Well, it makes a lot of sense to give a trade more days to try and go up to create a winner than to take a loss during the less common down days.
And when the market really falls apart, I am extra glad that I can only lose 100% of my option!
Now, some people think this means I am trading in a very risky way, but I tend to think in the exact opposite terms.
Because I know I am willing to lose 100% of the position, I can set up my risk in advance and feel very comfortable with the outcome of the trade — even if it loses.
Compare that to someone who buys a whole bunch of shares hoping an asset goes up and “plans on getting out of the trade if it doesn’t work out”...
I’ve seen that story way too many times and they open themselves up to way, way more risk than the alternative path of building an option play withcontrolled risk and being willing to lose it all if they’re wrong.
Let’s use ARM to consider this situation because that’s what I want to give you a free trade on today below.
As you will see, the trade on ARM I am recommending costs about $30 a contract to put on.
Meaning you can define your risk in increments of $30 if you want to follow this trade:
1 contract = $30 of risk
2 contracts = $60 of risk
10 contracts = $300 of risk
And so on.
On the flip side, the target is $70 per contract:
1 contract = $70 potential gain
2 contracts = $140 potential gain
10 contracts = $700 potential gain
And so on.
That’s a 233% potential gain on this setup.
Let’s Do Some Math
If the trade wins, we’ll make $70 per contract. And we need the stock to move about $8 to win.
To make the same $70 on a $8 move in the stock you’d need 9 shares, which at the current share price of $107 will run you about $960 total.
In short, that means you would be risking $960 to make $70 when buying the stock OR risking $30 to make $70 when using the option setup.
So, the very same reward will cost you about 32x the risk if you bought shares instead.
Now, you might say, “Sure, Nate, but I am not really risking the whole $960 on the shares…”
And to that I would say “First of all, yes you are! That’s how risk works.”
But even if you think the max risk is something like 50% of the shares and not 100%... Your risk is still 16x greater and you’re still tying up 32x more capital.
And that’s precisely why I love these controlled options plays!
Free Earnings Trade
Now, let’s jump into that free earnings trade idea I promised you at the beginning of today’s newsletter.
There’s one company in particular that I am bullish on this earnings season, and that’s Arm Holdings (ARM). ARM is a semiconductor and software design company known best for their CPU’s. They have the most popular CPU architecture in the world with over 250 billion chips shipped since the company's inception.
So why do I like ARM?
Well, ARM had one of the biggest earnings beats of the year so far in February and has over-corrected back to around $100 setting itself up for another big pop.
There are BIG bullish orders coming in on ARM right now betting on higher prices, so it looks like some insiders are expecting a beat.
And probably most importantly, chip stocks still have the most explosive potential of any sector in the market. ARM could miss and drop 20% just as easily, but that's why the controlled risk play makes so much sense.
In other words, I like it for its risk-to-reward potential more than anything else!
Here’s how we can play this:
We're going to place a debit spread expiring on Friday, May 10th on ARM.
To do this, we need to: | | • | | Buy to Open a May 10th $114 strike on ARM | | | • | | Sell to Open a May 10th $115 strike on ARM |
These options are at about $0.30 right now which means they cost $30 per contract to buy each one. So, if our options hit, we will make roughly 230% as our gain. What we risk is our entire premium, so again: 1 contract = $30 of risk
2 contracts = $60 of risk
10 contracts = $300 of risk
And so on.
And, remember, we are targeting the same gain on an $8 move as the underlying shares would require over 30x the investment to target.
And, in a nutshell, this is why I love options trading.
— Nate Tucci | | | | |
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