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How a Conservative Investor Uses Options to Reduce Risk


Here, some options strategies that even the most conservative investors can use to lower risk and protect the value of long-term holdings.

Tips for Placing Options Orders

1. Practice with a "virtual" account. To get a good handle on how options react to a variety of market conditions, use your broker's virtual money platform for a number of trades before applying the options strategies to real money.

2. Use only "debit" trades. There are a number of options strategies that will bring funds into your account immediately. These are called credit trades. When using credit trades, you are usually entering a more speculative investment than is normally made by a conservative investor.

3. Restrict the use of options strategies to only those stocks that have a high average daily volume. For most cases this means at least one million shares traded per day.

4. When selecting a specific option, look for only those that have a high Open Interest; generally at least 1,000.

5. Choose only options that have a small Bid/Ask spread. Those options with a spread of less than $0.10 generally give you better fills and will be easiest to close at a good price.

6. Do not purchase options that are far Out of the Money. These options decay very quickly.

7. Do not purchase options with only a few days left until expiration.

Some Typical Conservative Options Strategies

Covered Call:

This is considered the most conservative of all options strategies. Some say that it is even more conservative than buying only the stock. It is often used within IRA accounts. A conservative investor can approach the Covered Call from two perspectives.

Generate Regular Income:

This approach can be used to generate regular monthly or weekly income without selling shares of the company. You use this strategy with stocks that you hold if your expectations are that the stock price is not likely to increase over the near term, or might even go down a bit over the short-term.

Sell Stocks at a Premium Above the Current Price:

This approach can be used on a stock with which you would be comfortable selling, but only at a price that you stipulate. This is used for a stock that you are not in a hurry to sell. The sale of the Call may eventually take the stock from you, but at the price that you set when you sold the option.
No positions in stocks mentioned.
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