Wouldn’t it be nice to know the future?
Think about it…
It’d take the guesswork right out of picking your trades.
If you were able to see the future, you’d NEVER pick a trade that wouldn’t double – or triple- your money every single time.
And you’d always know if a trade is even worth your time… before you waste a single penny.
Now this may seem hard to believe…
… But you can see the future of any trade.
And in a matter of minutes, I’m going to show you exactly how…
Use a Risk Graph to Gauge Whether or Not A Trade is Worth Your Money … Ahead of Time
Risk graphs are a great way for you to see the theoretical value (or profit potential) an option has at different prices and different time intervals up until expiration based on the underlying stock price.
You can just as easily consider risk graphs as profit graphs because these graphs show both your risk on an option and your profit potential.
Let’s take a look at a risk graph on a long call…
If the option’s premium (the cost of the option) is $3.30, then your maximum risk potential is $330. Remember that one contract is equal to 100 shares, so you take the premium of $3.30 and multiply it by 100 shares to give you the maximum risk potential of $330.
The maximum risk is realized when the stock trades at $47 or below.
Here’s how that risk is graphed out…
Microsoft (NASDAQ: MSFT) June 17, 2016 $47 Calls
To see if your position can double in value, you multiple the price you paid to get in the trade by two. In the case the case of our MSFT calls here, you’d take the the $3.30 premium and multiply it by two in order to give you the $6.60 price that will deliver your double.
Using the risk graph, you’ll want to see if the stock shows any of those colored lines at that “Profit (S)” axis – even if you have to look at the black line (representing the option’s expiration). And if any of the lines hit the profit amount that you need for the option to double in value, then you know ahead of time if the trade is really worth your time pursuing – before you spend your first dime.
And if the graph doesn’t show a potential for the option to double in value…
… Then assess the return you can get (in either dollars or as a percentage) if the stock reaches the price you think it will. It will be up to you to determine if the trade still seems worth your time and money based on the return you’d get.
Microsoft (NASDAQ: MSFT) June 17, 2016 $47 Calls
The maximum risk shown above is for one contract. The option’s premium is $4.80 (or $480). The maximum risk is realized when the stock trades at $150 or higher. No matter how high MSFT goes above $150, the maximum amount you can lose is what you put in – $480.
Looking at the risk graph lines in the MSFT option scenario, can this option double in value any time between now and expiration?
Microsoft Corporation, (NASDAQ: MSFT) June 17, 2016 $150 Puts
The answer is no.
Now if the stock somehow dropped to $141 right now (the red line), then there’s a small chance of the trade doubling in value… But as I see it, none of the lines intersect at $480 on “Profit ($)” axis.
But before you move on to an entirely new stock and option… how about taking another look at these lines and seeing what happens if the stock moves to $141 – even if you have to wait until expiration for it to get there?
You can look at the stock price at any time interval, but why not look at the worst case scenario, which to me, is when the option expires. The reason this is the worst case is that you’ve run out of time for this trade to work.
Let’s say that at expiration, MSFT is trading at $141. The MSFT June 17 2016 $150 Put should then show a profit value of say, $410, along the “Profit ($) axis. The question now is whether or not you believe that MSFT will actually make it down to $141?
If you think it will, then your next step is calculating your theoretical return on investment – or ROI. A profit of $410 on a a trade that cost $480 is 85%. Now this isn’t a double… but 85% isn’t bad either.
And if you don’t think it will, then it might be time to consider a new opportunity…
The point of all this is… you can see the future of a trade using a risk graph. You can assess the theoretical value of an option when the stock hits a certain price at a certain time prior to – or at – expiration. You can also know ahead of time you’re your rate of return and profit potential could be … allowing you to decide whether or not you want to spend your time … and your money.
And the best part is…
A risk graph will help you determine the worst that can happen to your trade so that you can rest better at night.
Too many options traders place trades and fear the unknown. But no longer do you have to worry about what could happen to your trade – and when…
Risk graphs lay it out for you ahead of time.
Here’s Your Trading Lesson Summary:
It is possible to see the future of a trade… You can assess the theoretical value of an option when the stock hits a certain price at a certain time prior to – or at – expiration. You can also know ahead of time what your rate of return and profit potential could be … allowing you to decide whether or not you want to spend your time … and your money. All you need is a risk graph.
Until next time…