Most people think options are for speculators. They couldn't be more wrong! Options were created to cut risk. That's what the pros call "hedging." Smart option strategy lets you keep all the profit potential of buying stock with much of the risk removed. Interested?

Stock Replacement Strategy

The Stock Replacement Strategy is a great example of safe money option strategy. Instead of buying shares of stock, you buy deep-in-the-money call options. Don't get scared! This is simpler than it sounds.

The best way to explain is with an example. Let's use a stock I'll call ZZZ.

ZZZ is selling for $145 a share. 100 shares would cost you $14,500, plus commissions. That's a lot of money for most people.

• Instead of expensive stock, you could buy ZZZ July $95 Call options.

• One such Call option might cost you $7,695.

• That's only 53% of the cost of 100 shares of stock!

• These Call options give you the right to buy 100 shares of ZZZ for $95.00 per share any time until July, 2011.

Options

When you buy options, you buy the right to buy or sell stock, not the stock itself.

• "Deep-in-the-money" Calls let you buy stock for much less than its current price.

• You cut your risk by almost 50% when you replace the stock with the option!

• In-the-money Calls go up almost dollar for dollar with the stock - about $0.98. That's why you buy them.

Advantages

Let's look at your advantages -

• Risk only about half the money.

• Diversify your investments. What you save on one stock can be invested elsewhere. That also cuts risk.

• Don't just buy two Calls with the same money you would have spent on stock. Do that and you risk as much money without diversifying.

• Your percentage return is almost doubled.

• If ZZZ goes up $10, you make $1,000 on your $14,500 stock investment, a 6.9% profit.

• But if ZZZ goes up $10, you make $980 on your $7,695 investment in Calls, a 12.7% profit.

• If ZZZ goes down $10, the percentage returns would be the same - in the opposite direction.

What if ZZZ takes a big fall? Suppose some horrible surprise causes your stock to fall from $145 to $100? That's most investors' nightmare.

• Your loss on 100 shares of ZZZ stock would be $4,500.00.

• Your loss on one July, $95.00 Call would be $4,410.

• Your maximum possible loss with the stock is $14,500.

• Your maximum possible loss with the call is $7,695.00.

Risk is not eliminated, but it sure is cut.

Tips

Here are two tips for using the Stock Replacement Strategy -

• Always buy Calls with at least three months until they expire. That gives them time to rise. (Unlike stock, options have an expiration date, so you want to give yourself enough time.)

• Options lose value fast in their last month, so close out your position before then.