The Risk-Reduction Strategy Most Investors Refuse to Learn

Editor's note: Most investors think trading options is incredibly risky. But Retirement Trader editor Dr. David "Doc" Eifrig says one type of trade won't just boost your returns – it can significantly reduce your risk. In today's essay, most recently shared in the April 23, 2022 Stansberry Digest, Doc takes on the naysayers and details a better way to use this misunderstood trading tool...

Today, I want to talk about options...

Go ahead – you can stop reading this piece. I know that most of you probably know enough about options to think they're complicated and risky.

But then again... the first time you tried to drive a car, it seemed complicated and risky, too. Now you do it every day. You put the time into learning how to drive because it made your life better.

Options will do the same for your finances. And just like learning to drive when you were 16, better finances and larger income streams give you more freedom.

I don't blame options skeptics.

I blame those who taught them options. Most folks get introduced to options the exact wrong way... as a strategy for making big, fast gains in the stock market. But when put into practice, this "big gain" tactic leads to big losses.

So today, I'm going to show you the right way to use options. As you'll see, we can use options to reduce our risk... while creating returns that don't exist for other investors.

If trading options doesn't scare you, does the word "derivatives"?

Options are considered a type of derivative – a broad term for investments that are based on other investments. With derivatives, you don't invest in an asset. Instead, you bet on a contract that "derives" its value from something else.

During the 2008 to 2009 financial crisis, you couldn't find a word scarier than derivatives. Remember hearing about those credit default swaps that nearly blew up Wall Street? Those were derivatives. They were bets that tied their payoffs to the default status of mortgage bonds.

Perhaps you read about rogue trader Nick Leeson blowing up Britain's Barings Bank in 1995. He was using derivatives. Or maybe you remember Jérôme Kerviel, who lost 4.9 billion euros for French bank Société Générale with derivatives. And you likely recall when U.S. financial-services giant JPMorgan Chase (JPM) lost $2 billion to the "London Whale" in 2012, again due to derivatives.

These guys give options and derivatives a bad name. They used them as a way to load up on risk and leverage, making massive bets with little capital up front. Of course, their bonuses depended on taking stupid risks.

That's the perception novice investors have regarding options... But it's flat-out wrong.

With options, you can make a bet on whatever sort of market activity you expect.

A typical investor has two ways to play the market: He can buy stocks he thinks will rise, or short the stocks he thinks will fall.

An options trader adds several more tools to his bag. He can bet that stocks will rise, fall, stay the same, move within a certain range, rise then fall, and just about everything in between. Options can be used to increase leverage and risk... or just as easily, to reduce it.

But most investors do it the wrong way.

The standard options pitch goes something like this...

Let's say you think a $20 stock is going to rise. Well, you could buy 100 shares for $2,000. If the stock rises to $25, then you'll have $2,500... a profit of $500. That's a gain of 25%.

Instead, you can buy a call option on that stock for just $150. Since each options contract represents 100 shares of stock, with your $2,000 investment, you can now "control" 1,300 shares instead of 100. (Remember, each options contract covers 100 shares.)

Based on this particular option, if the stock rises to $25 within the month, you'll turn your $2,000 into $3,250. That's a 62.5% return. Phew!

Who wouldn't be interested in boosting their returns like that?

The trouble comes with the first assumption. You may think a stock is going to rise... But when you trade options like this, you're making a leveraged bet that a stock will make that move in a very specific period of time.

No matter your investing prowess, you're going to get that wrong most of the time. And when you get it wrong, you'll likely lose your entire investment.

People who learn to use options this way often lose their shirts on the first trade and quickly give up.

But there's a better way. It involves doing the exact opposite of the folks who lose money trading options.

Let me ask you a question... Is poker a game of skill or chance?

On the one hand, you need to get great cards. You can make all the right moves but still end up busted by a straight flush. On the other hand, making careful moves and controlling your risk tends to pay off in the end.

People argue over poker because it's hard to prove that skill beats luck. Even the best player can lose any single game, months of games, or even years of games.

But here's the question that settles it for me: Can you sit down at a poker table and intentionally lose all your money?

Stupid question, right? Of course you can. The reason poker is a challenge is because everyone is pursuing the same strategies and the same ultimate goal. That competition makes any edge you hold a small one.

But when you take the opposite strategy as everyone else... it's easy to succeed. It's easy to reach your goal.

My options strategy flips the game so that we're the only ones playing a certain way...

In short, most individual traders buy options. And most of the time, they lose money. In my Retirement Trader advisory, we sell options... And we almost always make money (since 2010, 94% of our positions have been winners).

That's the key to our strategy. Selling something you don't own sounds like an impossible arrangement. But it's just the vocabulary that makes it confusing.

So, if you knew you could make double-digit returns... while reducing your risk... and do so even if the market goes nowhere for the next few years... would you take an hour to learn how?

My bet is you would. The only thing holding you back is what I call "options baggage." Options trading looks difficult, and many people have traded options improperly in the past and lost money.

Drop that baggage.

Keep an open mind, and I promise you that absolutely anyone can learn how to make conservative, risk-reducing options trades.

Here's to our health, wealth, and a great retirement,

Dr. David Eifrig

Editor's note: Right now, as volatility continues, Doc is challenging readers to try something different... for the sake of their retirement savings. With this strategy, you could potentially collect thousands of dollars every single month – no matter what's happening in the markets – with less risk than buying stocks outright. Get the details here.

Further Reading

"You can make hundreds, even thousands in extra income per month by selling options," Doc explains. What's more, his low-risk options strategy gets even better in times of market uncertainty... Learn more here: The Prisoner-of-War's Secret to Outsized Gains.

If you use options the smart way, you can actually take on less risk than a buy-and-hold investor. But today's young "meme stock" traders are getting this strategy completely wrong... Read more here: Look at Today's 'New Investors'... And Do the Opposite.