The Power Of Leverage (And How We Bagged A 671% Return In A Month…)
We’re usually taught that “leverage” is a dirty word. And I get it, there are good reasons for this.
For most people, when it comes to investing, leverage should be avoided.
But in just a second, I’m going to show you how leverage can be your friend – if you know what you’re doing and are disciplined, of course.
You see, one of the best-kept secrets of truly wealthy investors is the ability to properly employ leverage. If done right, you can stretch your capital to maximize gains while still limiting your risk.
And one of the best ways to do this is with options.
Now, before you write this off completely, just stick with me here. Because once you understand what’s possible (and how to manage risk), you’ll see why there’s absolutely nothing wrong with using options as a component in your overall portfolio. In fact, it can be a valuable tool to power your portfolio to the next level.
The Power Of Leverage (Done The Right Way…)
If you’ve ever bought a home before, then you’ve used leverage (unless you paid cash, of course).
Let’s say you bought your house for $350,000 several years ago (back when that could buy a very nice place in many parts of the country).
But in this red-hot market, you decide to sell. The house goes for $420,000, making you $70,000 on the purchase price. That’s a nice 20% return.
Except, you didn’t pay the full price upfront.
Let’s forget about your mortgage payments and real estate commissions for the sake of this example. Let’s also say, like many people, you put 20% down on the original purchase price, or $70,000. When you sell, you not only get that original principle ($70,000) back, but the profit (another $70,000) is also yours to keep.
That’s a 100% return on your money from a 20% move in price. And that’s the beauty of using leverage the right way.
Options work in a similar manner. Some trades are meant to profit from an expected downward move in a stock. Others are designed to generate income if the stock moves sideways. There are even complicated strategies involving two or more options contracts working in tandem.
For the sake of this discussion, I’ll keep things simple and focus on the way we use options over at my premium Takeover Trader service. And that’s by using call options.
How To Magnify Your Returns
Before we go any further, let’s get some of the basic terminology out of the way.
An option is a contract that represents an interest in 100 shares of a specified stock or exchange-traded-fund (ETF).
Call options convey the right (but not the obligation) to purchase an underlying stock or security at a fixed, pre-determined price, known as the “strike” price.
In return, the buyer must pay what’s known as a premium. This is the cost of the contract, expressed on a per-share basis.
Each contract will have an expiration date. This is the month and day on which the options contract will expire.
When we buy calls, we are typically expressing bullish interest in the underlying stock by paying a premium to participate in the upside. The larger the move, the more we make.
For example, back in September 2020, I told my premium readers bout the communication software developer Twilio (Nasdaq: TWLO).
The company was massively benefiting from the “stay at home” trend, the business showing some serious momentum – enough, in fact, that I thought chances were good for a potential buyout. But investors were wondering if the trend was playing out, and the stock had fallen from a recent peak near $280 down to $220.
So I gave my readers two potential trades.
One was to simply buy shares of the stock. Nothing wrong with that at all. In fact, shortly thereafter, the company revealed in a presentation that it expected revenues for its next quarter to reach $406 million — a growth rate of more than 40%.
The “stay at home trend” was still in play.
The stock went on a furious rally after that. We finally sold out of this position in October at $329, netting investors who chose this route a 49% gain in less than a month.
That’s a great return by any stretch. But then there was the second choice…
The other choice I gave readers was to buy the November 20 $280 calls. That’s a call option on TWLO that expired on November 20th with a $280 strike price.
At the time, these particular calls were trading for a $7.45 premium. That means for every contract, we were only risking $745 to control 100 shares. And thanks to that incredible rally, this contract was trading for $57.45 by the time we fully exited the position. That’s an incredible 671% return.
Below you can see how this trade would have played out if you had bought 100 shares of TWLO compared to just one of these call options.
By risking just $745 you could have controlled the same amount of shares if you had risked $22,000. And in return, you could have made nearly half as much.
That’s the power of options. Of course, if we bought two calls, it would have been twice the profit. And in the worst-case scenario, we are only risking $745 if the option expires “worthless”.
Now, there’s a lot more to say about how buying calls works. We’ll save some of that for a later time. And not every trade we make will make these kinds of returns — and a few of them may not work out at all.
But the point is, if you think buying calls are difficult or if you’ve heard that options are risky, then it’s time to put those concerns to rest. Like many things, there’s a “right” way to do it and a “wrong” way, which is why you need to be fully aware of not only how this works, as well as the risks.
The choice is completely up to you. But when these kinds of gains are possible in such a short amount of time, I wouldn’t be doing my job if I didn’t at least make you aware of how this works.
In the meantime, I encourage you to check out my latest presentation. In it, you’ll learn about the three sectors I’m targeting for a “feeding frenzy” of takeover deals in the coming months – and how you can profit. You’ll also see examples of previous trades we’ve made (both with options and without), where we’ve made double and triple-digit gains in a matter of months.