My school years didn’t teach me how to manage or control risk; in fact, they taught us to avoid risk. The general philosophy was to go to school, get good grades, and get a high-paying job.
In 1999, I decided to forgo college despite having a 4.4 grade point average. I joined the United States Marine Corps instead, which you could consider risky.
Because I took a different route, I retired at age 42, while my buddies were still grinding away in the workforce. There is something about managing risk that we must all learn.
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A good way to learn to control emotions and manage risk is through options trading. Options trading gives you the maximum amount of risk because they use “leverage.” Leverage is both good and bad, and only you can decide how to employ it.
Why learn about risk? Most people avoid risk at all times. They stay at a job that they know will end soon, yet they will work until they receive a pink slip.
Most of my friends in the military never owned multiple homes at once, although it was the perfect time to accumulate a small collection of houses. They believed owning multiple homes was risky.
I left the Marine Corps with three homes at great interest rates (2.0%, 3.0%, and 3.5%). I overcame my fear of being a landlord and managing money.
Fear is a powerful emotion, and one you must conquer. If you don’t overcome your fears, it could make you want to work forever—hopefully, you don’t want that.
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What is options trading? But how can trading options help you manage your risk tolerance? Options trading is basically gambling; however, you can beat the house.
Only one person alive can tell you how to win at options—you. You must make the calls to sell or buy your option contracts for a profit or a loss. The more you identify and mitigate risks, the stronger trader you become.
Options trading is a game based on stock derivatives. One hundred shares of a company’s stock make one option contract.
You can bet the stock will go up (call option) or down (put option). You can sell options, giving the buyer insurance, or you can buy options to insure yourself.
Options trading gives you massive leverage because you control 100 shares of a stock for a fraction of the price. However, with great power comes great responsibility.
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Getting started with options trading. I do not recommend jumping directly into options trading because it is a dangerous world—a very dangerous world.
I highly recommend you understand a few principles of interest rates before you trade options. Here is a checklist that you should be able to answer.
- What are the current Federal Funds Rates?
- What are current mortgage rates?
- What is the difference between Treasury Bills, Notes, and Bonds?
- What are preferred shares?
- What are closed-end funds?
- What are the following index funds: QQQ, SPY, DIA, and VTI?
If you cannot answer the following questions, learn before doing anything else. Why are these questions vital to options trading?
All of these questions relate to interest rates and return on investment. You must comprehend money and interest before playing in the land of options. Why?
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Because you will receive some big paydays when you trade options, you must compare your earnings to standard products to judge when to stay in the game or pull your money out. Let me walk you through a scenario.
Let’s play a game. The current Federal Funds Rate is 4.25% to 4.5%. The rates on Treasuries are: 1-year (4.03%), 5-year (3.98%), 10-year (4.25%), and 30-year (4.63%).
You can earn about 7-8% on preferred shares and 10-12% on select closed-end funds. Index funds average around 8-10% annual growth over 10-15 years.
It’s important you know this as you trade options. Let’s say you sell 10 Rivian (RIVN) covered calls and receive $700 upfront ($70 apiece). You own 1,000 shares of Rivian for a total cost of $12,000.
This is a one-month options contract, meaning you can do the same thing twelve times. What is your annual rate of return? 70%.
Let’s do the math. Multiply $700 by twelve to get your annual income of $8,400. Divide that annual income by the base amount spent ($12,000). This leaves you with an annual return of 70%.
That’s why it’s vital you understand all other rates of return. Many people get into options trading to get rich. It can make you rich but over time.
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If you remain calm and perform intelligent trades, you’ll slowly build your base of passive income and trading knowledge. That’s how you accumulate true wealth.
Ways to manage risk. One way to manage risk in options trading is to sell covered products such as covered calls and cash-secured puts. I like these products very much.
If you want to increase the risks, you can trade long strangles, which is also one of my favorites. The stakes are much higher with long strangles, therefore, you must plan accordingly.
If you have a $10,000 options trading portfolio, you want to mitigate risk by only playing around $4,000 at a time. It’s risky to play your entire hand at once.
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Long strangles already have built-in protection, as one put option and one call option make up one long strangle. Therefore, you can win if the stock goes violently in either direction. The risk is that the stock stays in the middle and your option contracts timeout.
Real-world consequences. Learning to manage your options portfolio has real-world implications. You’ll learn to see that risk mitigation is everything you do.
Options trading is a highly emotional affair. Let me repeat—options trading can make you want to cry sometimes. It’s brutal. You’ll feel like a complete idiot at times.
However, you’ll start overcoming these emotions, which will help you in real life. When you have to make decisions like buying a house or moving to a different state, you’ll be able to remove some emotion and insert more logic.
In options trading, you must always plan for the unknown. There is always a random event that throws off your plan. You must decide, rather quickly, to stay or exit.
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Managing this fight-or-flight mentality will be great in the real world. You’ll be able to see clearly whether there is a risk or not.
Conclusion. For example, let’s say you are happy in your home but would love more land. What’s the risk in looking?
You’ll be able to talk clearly to the real estate agent and tell them you are happy but looking. This allows them to mitigate their risk.
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If they want a fast sale, you’re not the person. However, they may get lucky and find a house for you if they have patience. Everyone is on the same page.
When you call your lender, you can tell them your requirements. If they offer you a bad rate, you can smoothly walk away. You have nothing to lose.
Trading options is the ultimate form of risk mitigation. When your contracts are flying high, do you sell them? When they are low, do you get out?
You must create, institute, and abide by your own set of rules. Creating your own rules and having the discipline to follow them is the heart of options trading and risk mitigation in general. Good Luck!
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Disclosure: I am not a financial advisor or money manager, and any knowledge is given as guidance and not direct actionable investment advice. I am an Amazon Affiliate. Please research any investment vehicles that are being considered. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. All Right Reserved Military Family Investing
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