Sometimes stock markets go down. Sometimes they do this for a lengthy period of time. If the share market is trending down, one way of making money, in what would seem to be the worst possible time for making money, is to use options.
An option will allow you to sell shares at some time in the future even though you don't currently own any shares.
The way this works is you buy an option to sell 1,000 shares of XYZ stock in one month's time for a stated price. You have to pay some money for the option to do this. In one month's time, when the price of those shares has fallen, you then buy those shares and immediately sell them again at the price that was agreed in the option. The person that you bought the option from has to buy those shares off you at the agreed price, if you choose to sell.
For example, an XYZ share might be worth $10. The market is falling. You buy an option to sell 1,000 shares of XYZ at $9 in one month's time. The option costs you $10. In one month's time the price of XYZ has fallen to $8 a share. You immediately buy $8,000 worth of XYZ and then sell them for $9,000. You have made $990 profit ($1,000 less $10 costs).
An option, in this case, is an option to sell. You don't have to sell. It's your choice. If XYZ had instead bucked the market and gone up to $11 a share you could buy 1,000 shares for $11,000 and then sell them for $9,000 if you wished. You would lose $2,000, so it's not a good idea. Given that you have the option to sell, you can choose not to exercise the option and to not lose $2,000. You have, however, still lost your $10 option fee.
Shares, even with options, is still gambling. If you have your eyes open and your ear to the ground, you can make a lot of money with options. The trick is to have enough good information to know where the market for a share is going.
In the example above, you could have made a $1,000 profit for a $10 investment. This is a 10,000% return on your investment. Whilst such a percentage seems absurdly and unrealistically high, these sort of results are possible with options. They are extremely leveraged. In this case $10 down controlled $10,000 worth of shares. In property, you would have $20,000 down controlling a $100,000 property.
Posts in this blog should not be taken as investment advice, merely as views of a general nature. Individuals should seek qualified advice tailored to their specific circumstances from licensed advisors.
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Interestingly (and annoyingly and devastatingly), we are currently seeing the share market going down for a long period of time.
ReplyDeleteOne thing that did happen was government intervention banning "short selling" or "naked puts" which are words for what was described here - selling shares you don't currently own.
Whilst painted as a dreadful thing to do by its opponents it was a legitimate way to make money. People sell options so they are guaranteed a price when "things" are ready. The best examples are farmers fixing a sell price for crops that haven't grown yet. That way they could get loans to grow the crops as banks knew they had guaranteed sell prices.