While simply buying a basket of miners and waiting a few years can, and will, provide significant upside - if silver hits $100-$150 over the coming five years (a 4-6X increase), and it should, junior miners should provide 3-5X leverage on THOSE gains, totaling 12-30X returns. Pretty healthy.
But along the way that strategy will come with weeks to months of nauseating volatility and backtesting that will make it very hard to remain in the trade, and will tempt even the biggest balls to nut up or cash out.
Along that road there will be no shortage of inflection points that allow for targeted, 10X trades, risking a fraction of what one otherwise might, being heavily invested in volatile miners. But to do that, we need a high leverage vehicle that gives us exposure to that kind of upside, without the same degree of risk. Fortunately for you and me, those vehicles exist.
1) What Are Options?
Think of options as contracts that give you the right, but not the obligation, to buy or sell a specific amount of a stock or commodity at a predetermined price (known as the strike price) within a specified timeframe. You have two types of options: calls and puts.
- Calls: Buying a call option gives you the right to purchase the underlying stock at the strike price before the option expires. It's like having a golden ticket to buy the stock at a discount.
- Puts: Purchasing a put option grants you the right to sell the underlying stock at the strike price before the option expires. It's akin to having a superpower to sell the stock at a higher price than the market value.
2) Factors Affecting Options Pricing
The price of an option is influenced by several key factors that you must understand to navigate my trading strategy successfully. Let's dive into these important factors:
- Stock Price: The current price of the underlying stock plays a significant role in determining an option's value. If you hold a call option, you want the stock price to rise above the strike price for the option to be profitable. Conversely, if you hold a put option, you hope the stock price falls below the strike price. The larger the difference between the stock price and the strike price, the more valuable the option becomes.
- Time Decay (Theta): Time is a critical factor in options pricing. As each day passes, options lose value due to time decay. This means that even if the stock price remains unchanged, the option's price will decrease over time. The closer the option gets to its expiration date, the faster it loses value. It's important to consider the time remaining until expiration and make timely moves to maximize profits.
- Volatility (Vega): Volatility measures the magnitude of price fluctuations in the underlying stock. Options prices tend to increase when the stock market experiences high volatility. This is because volatile markets offer greater profit potential. When volatility is low, options prices are generally lower as well. Monitoring the volatility levels is crucial as it can significantly impact option prices.
- Delta: Delta represents the sensitivity of an option's price to changes in the underlying stock price. It tells us how much the option's value is expected to change in response to a $1 movement in the stock price. For call options, Delta ranges from 0 to 1, while for put options, it ranges from 0 to -1. Delta helps us assess the risk and reward of different options strategies and understand how much an option's price will move in relation to changes in the stock price.
While I don’t find these factors particularly useful in mathematical terms, knowing that AND how each factor affects price is very useful. This is why, for example, we want to buy during low volatility windows (during price consolidation (coiling) before a breakout) and sell during high volatility periods. Chasing price after a breakout might lead you to pay much more for an option, as it’s volatility has increased. Then, if the market stalls or retraces, you very quickly wind up in a losing trade where time works against you.
3) The Dance of Profitability
Let's look at an example to see how options can work their magic. Imagine you're eyeing a call option on ABC Company. The stock is currently trading at $50, and you purchase a call option with a strike price of $55 and an expiration date one month away.
Here's the fascinating part: If the stock price climbs above $55 within that month, your call option becomes profitable. The further the stock price surpasses the strike price, the more profit you can make. For instance, if the stock jumps to $60, you can buy it at $55 and immediately sell it for $60, pocketing $5 per share profit (Note: you don’t actually need to convert the option to the underlying stock - you can merely sell it and pocket the profit).
However, if the stock fails to rise above the strike price by the expiration date, the option may expire worthless, and you'll lose the initial investment. That's why timing and understanding the movements of the stock are crucial.
We’ve already discussed markets and position timing for the WHERE and the general HOW of a trade. We’re going to put this system on steroids next by capitalizing on mispriced risk, and we’re going to survive the long game by implementing betting strategies that minimize risk on any one trade.
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