I often get asked why I love trading put options so much.
Why don’t I trade more common shares? And why do I rarely buy calls?
The truth is that once I discovered options trading, it was hard to get excited about trading common shares.
If I’m watching a stock, and it’s optionable (with decent liquidity) — I’ll ALWAYS pick trading the options over the shares.
If I’m right about the direction the chart is headed in the near term, I’ll almost always make more money if I trade options (as opposed to shares).
If I trade shares, I’ll be hoping to eke out 10-20% gains. And I’ll need to risk a lot more money to make anything close to what I would on the options.
But that’s just the tip of the iceberg…
Let’s go over three reasons why I love trading put options more than anything else in the markets.
Reason #1: Defined Risk
If you’ve been following my trading for a while, you know I have a negative bias.
In other words, I like to bet against stocks as opposed to going long.
And my favorite way to short overextended names is via put options.
Why? Because, unlike a traditional short position, puts allow me to define my risk. Let me explain…
When you short common shares, you take on theoretically unlimited risk.
Think about it. Hypothetically, the stock you’re shorting could surge to any price at any given time.
(Out of all the things Tim Sykes taught me in the Trading Challenge, the dangers of shorting common shares always stuck with me.)
On the other hand, if you trade puts you can never lose more than your principal. If you buy $100 worth of puts, the most you can lose is $100.
Bottom line: Put contracts let you decide how much you’re willing to lose (instead of taking on unlimited risk by shorting shares).
Reason #2: HUGE Potential Rewards
Now that we’ve clarified how put contracts help me define my risk (and why normal short positions are so dangerous), I’d like to move on to my favorite reason for trading put options — massive potential profits.
The most you can make off a common-share short position is 100% on your initial principal. And that’s if the stock crashes to $0 (not likely).
But depending on when you get into the contracts, puts can pay ENORMOUS multiples on your principal.
I’ve seen traders make 10x, even 20x gains on put contracts before — which is impossible if you’re shorting shares.
Take my biggest trade of all time as an example of what’s possible when you trade put options with discipline…
Last February, I caught a supernova reversal move in Riot Blockchain Inc. (NASDAQ: RIOT), when it went from about $56 down to $46.
I nailed this trade, profiting just shy of $128,000 (still the biggest gain on a single trade in my career)!
Bottom line: The risk/reward on puts is considerably better than it is on common-share short positions.
Reason #3: Stocks Crash Quicker Than They Rally
There’s an old saying that says, “Stocks take the stairs up and the elevator down.”
I want to catch that elevator down, as you can generally make more money in a single day on the downside than you can over entire weeks on the upside.
I could show dozens of different charts to illustrate this concept, but the ViacomCBS Inc. (NYSE: VIAC) chart from last April is a particularly dramatic example:
See how long you would’ve needed to patiently hold this stock on the way up?
But had you nailed the downside with put options, you could’ve made a small fortune in less than a week.
Four days of downside took out 6 months of upside in VIAC.
This sudden capitulation happens over and over again in overvalued momentum stocks — and that’s exactly why I work so hard to find five-star put trades.
There are many other reasons why I love put options, but the three points we covered today are my basic motivations for trading this strategy.
In the coming weeks, I’ll be going into more detail about the specifics of my put-trading strategy (and I might even be revealing a brand-new one soon).
Until then, take my advice … If you plan on betting against a stock, buy puts and don’t short common shares!