Supeman can leap tall building in a single bound. Therefore, let’s look at building wealth using a conservative strategy to leap tall financial buildings too.

Are options risky? I hear people talk about the risk in options all of the time. Even the disclaimers from companies such as Scottrade, Schwab, etc. provide handout material on the risks associated with options.

However, people are risky.

Let’s say there is a company that I want to own. XYZ’s stock is trading at $50 today with a target of $60 in twelve months.

If I buy 100 shares it will cost me $5,000. If I have a stop loss of 15%, I could lose $750. If the price goes up to $60 per share I would gain $1,000.

$1,000 / $5,000 = 20% gain with a 15% stop loss as protection.

However, I like options.

In all likelihood, I won’t own a stock for three years. I’m not a buy and hold person, because too many things go on. See my post Buy and Hold is a thing of the past.

So let’s say I want to control the stock without owning it. I’ll buy a LEAPS option. (Long-Term Equity Anticipation Securities). These options are good for up to three years. I could gain, or lose, on the stock without owning it for a long period of time. The thing about options in the U.S. is I can buy/sell at anytime and do not have to wait until expiration to do so.

Let’s say today’s price on a January 2012, $50 option is $8.10. One contract controls 100 shares. It would cost me $810.

Options use Delta as a way to gauge its performance, price, etc. If the Delta is .5, in simple terms, that means the price of the option moves $.50 for every $1.00 the underlying shares move. If the stock goes to $60, that’s an increase of $10. The option price moves $5.

My profit would be $500 on an investment of $810. The gain is 62% and my risk is $810 if the option expires worthless.

Here is one more thing to consider.

If I took the difference between owning the stock and buying the option, I would have $4,190 sitting in the bank. At 3% interest (although it might have to be in a 5 year CD right), I would make approximately $125 per year. Take $810 – $125 and now my cost is really $685.

Also, I can close out my option and lose less if the stock goes bad. However, my loss is much less than if I purchased the stock outright. If the stock drops to $40, my loss on ownership would be $1,000 for my investment, but the option should only lose around $500 which reduced my loss by 50%.

Although the gain is not as large in dollar amounts as owning the shares, neither is my cash outlay. And if this option is considered expensive, by looking at the implied volatility, I may just sell the option instead and get paid versus paying money. See my post How To Make Money Without Spending Money.

Options are really pretty easy to understand, but there are things you must learn about them. I keep doing homework (homework is not just for kids in school). Maybe someday I’ll be able to LEAP tall buildings in a single bound just as Superman does; and, as Mark Whistler stated in his book Volatility Illuminated – Superman wears his underpants on the outside which is something else not every one does either.