As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.
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With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world. Follow Option taking strategy Follow DanCaplinger Just when you thought the market was safe again, a day like Monday serves as a stark reminder that despite the huge losses of the past year and a half, stocks can still fall further.
In response, many people have scurried for cover, looking for investing strategies that will allow them to reduce their risk. Few of these investors will look to options strategies for solutions to their risk management concerns. Yet while many investors use options to magnify option taking strategy rather than controlling it, a variety of options strategies exist that can actually reduce your exposure to the market -- while still allowing you to reap some of its benefits.
The lose-everything trap Options strategies get complicated in a hurry, and with good reason: for every stock, there are dozens of different options available, and an even greater number of combinations of options you can put together to achieve a particular goal.
By choosing one option over another, you can be bullish or bearish, risk a small amount or a huge one, and control the likelihood of making a profit. The biggest concern in using options is how easy it is to lose your entire investment.
For instance, if you're bullish on a stock but want to limit your downside, buying a call option gives you the best of both worlds: profits if the stock rises, but limited loss if the stock falls. The problem, though, is that you can easily lose your entire investment in an option if things don't go your way.
The Bottom Line Buying undervalued options or even buying at the right price is an important requirement to profit from options trading. Equally important — or even more important — is to know when and how to book the profits.
Spread out your risk That's where spreads come in. Spreads involve using two options: buying one and selling one.
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For a bull spread, you buy a call option with a given strike price and sell another call option with a higher strike.
Compared to just buying the call option outright, a option taking strategy spread limits your upside, but the overall position is often much cheaper.
A simple bullish options strategy would be to buy a call option. In contrast, a bull spread might involve buying the May 50 call but selling the May Limiting risk Bull spreads let you bet on rising shares, while the similar bear-spread strategy involves put options and pays profits when shares fall.
Depending on exactly which options you use, you can change your risk profile substantially. Here are a few more examples: Stock.
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