Reddit user turns $35k into 1.2million dollars. This is good.. right?
July 12, 2020Jasen Baker
What can you learn from the recently rich?
In this video, I detail the trading journey a user on Reddit r/wallstreetbets posted on how they went from $35k to $1.2Million in just 3 months. By leveraging the power of options, he was able to grow his account exponentially.
Was it luck? Was it skill? What it the right time and right place? Options require skills, and when you aren't applying skill, you can rely on a lot of luck. The markets have been in historical ranges of volatility which makes the prices of options sky rocket. When using directional options, it can be a double edged sword. You can quickly see from his balance history above, he had some big moves up and big moves down. This isn't something the average investor can emotionally handle.
But with this success, what can we learn? How can you apply these techniques to your own trading?
The biggest takeaway was over leveraging his account. If you have $10k, $100k, or $1m worth of funds to trade with, you never want to put an overly large portion of that fund into a any single trade. The risk of a trade going to zero depends on the trading instrument used. In the case of this Reddit user, he was using Options. I personally love trading options, but I also respect how they can wipe out an account quickly.
Stock Options are designed to be worthless. Because stock options expire on a specific date and are designed to be sold around a specific strike price (aka the price of the underlying stock they represent) if the stock doesn't reach the key price level you've purchased, by the time of the expiration of the option, then the option will expire worthless and your full purchase price of the option will go to zero.
It's clear from his P&L (Profit and Loss) chart that he must have put 50% or more of his entire portfolio into one trade. Just imagine, you put 50% of all you have on RED on a roulette wheel. One spin, and if it comes up black or 0, you lose it all. That's a huge amount of risk, and not a long term strategy I'd ever take on myself.
However, buying options isn't the same as buying a stock. When buying stock, all you have to do is buy it, hold it until it's profitable. If it's not profitable, you get to decide when to take your loss. Options are more complicated, when buying, because you have to decide at which strike price you wish to purchase and how much time on the contract you would like to buy.
The price of an option is based on it's strike price (The price the option can be traded in to actually own the stock), the intrinsic value (the positive difference between the strike price and the option price), and the "premium" which takes into consideration the current volatility and time left in the contract.
For example, if TSLA (Tesla) is selling for $500, and you would like to buy $100 shares of TSLA (Tesla) it would cost you $50,000 out of pocket and that's a LOT of money. You could however buy a stock option to buy TSLA for $500. The option will give you the "right, but not the obligation" to purchase TSLA for $500. It's like an IOU, but you paid for the IOU and you also decide if you want to cash it in and buy those shares.
So what would the price of the option be? It depends on two other factors, but mainly, what is the volatility of TSLA (Tesla), meaning how far up and down does the price move in say the last 30 days, and how many days until the contract expires.
If you feel TSLA will remain above $500, and it's going to $600 in the next 30 days, perhaps you buy an option contract for $10.00 per share, or $1,000 total for the right to purchase 1,000 shares. You are basically putting up $1,000 to purchase 100 shares of TSLA @ $500 per share sometime in the next 30 days.
If you don't "exercise" your option in the next 30 days, you will lose your $1,000 investment. However, that may be a small price to pay if TSLA falls below $500. However, if TSLA goes to $600 per share, you could sell your original contract!
A contract usually represents 100 shares, so if you paid $10 per contract, and TSLA was selling for $600 at the end of 30 days, your contract is guaranteed to be worth $100 per contract or 100x $100 = $10,000. Thus your initial investment of $1,000 how now grown by 10x!
So you can see the power of options. If you are right about the direction AND the time the movement will occur, you can benefit handsomely. However, the market is smart, they won't give you those contract prices for cheap. They have studied as well and know the value of where TSLA could go, so you have to make sure what you pay for that contract is going to be worth the risk of it going to zero.
A big lesson is to respect the power of options, and not bet the bank on them, but diversify your risk across multiple sectors and industries so any one trade doesn't wipe you out.
** Interested in how I trade? Check out my On-Demand webinar to learn more about the D.A.T.E. Trading strategy and get a special offer code just for watching!
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