Over the past few decades, we’ve seen many advances in how the stock market functions. Today, exchanges and brokerage houses exist almost entirely online, and everyone is competing for microseconds of speed.

We’ve also seen the idea of “investing” evolve into something much more advanced and complicated than it was in the early days.

I’ve spent my entire 18-year career immersed in the finance world. And in my experience, no matter what data, methods, techniques, witchcraft, mojo or voodoo you choose to use for your investments, it is absolutely critical that you understand what you’re doing. If not, you’re just another amateur grasping for success.

The truth is, today’s “game” requires an increased arsenal of tactics and methods to prosper. And for the average investor, a powerful options strategy is one of those tools that should be used.

#-ad_banner-#I realize some of you may have never considered using options in your own portfolio. That’s OK. I want to use today’s essay to explain some of the basics and demystify options so that you can use them to amplify your profit potential and limit the downside.

The truth is, options can be as simple or as complicated as you want to make them. Just know that when you purchase options as a means to speculate on future stock price movements, you are limiting your downside risk, yet your upside earnings potential can be unlimited.

Aside from speculation, investors also use options for hedging purposes. It is a way to protect your portfolio from disaster. Hedging is like buying insurance — you buy it as a means of protection against unforeseen events, but you hope you never have to use it. The fact that you hold insurance helps you sleep better at night.

Today, I want to talk about one of the most basic ways investors use options: buying call options.

Investors generally buy calls on stocks they expect to move higher. But rather than simply buying shares, savvy investors use calls to amplify their upside. Let’s take a look at a theoretical example to see how this works.

Example: Call Option Contract
As a quick example, let’s say IBM is currently trading at $100 per share. Now, let’s say an investor purchases one call option contract on IBM with a $100 strike price at a premium of $2.

That premium is the price you’re paying for the right to buy 100 IBM shares for $100. But rather than costing us $10,000, like it would on the open market, we’re only paying $200 (100 shares x $2 = $200).

Here’s what will happen to the value of this call option under a variety of different scenarios:

When the option expires, IBM is trading at $105.
The call option gives the buyer the right to purchase shares of IBM at $100 per share. In this scenario, the buyer could use the option to purchase those shares at $100, then immediately sell those same shares in the open market for $105. Because of this, the option will sell for $5 on the expiration date.

Since each option represents an interest in 100 underlying shares, this will amount to a total sale price of $500. Since the investor purchased this option for $200, the net profit to the buyer from this trade will be $300. That’s a 150% return on a 5% move in the underlying shares. Not bad.

When the option expires, IBM is trading at $101.
Using the same analysis as shown above, the call option will now be worth $1 (or $100 per contract). Since the investor spent $200 to purchase the option in the first place, he or she will show a net loss on this trade of $100.

When the option expires, IBM is trading at or below $100.
If IBM ends up at or below $100 on the option’s expiration date, then the contract will expire “out of the money,” meaning it will now be worthless. In this scenario, the option buyer will lose 100% of his or her money (in this case, the full $200 that he or she spent for the contract).

That alone isn’t the end of the world, since we’re only talking about $200 and not thousands of dollars. But many of my Profit Amplifier readers choose to trade with larger position sizes, so that’s why we use deep “in the money” calls that have a higher probability of being profitable. We also use stop-loss orders. After all, there’s no sense in being greedy when we can protect ourselves and still profit.

Buying call options is one of the most basic and common options strategies, and you can use it as a substitute to simply “going long” and buying a stock. And by taking a sensible approach to our trading strategy, we’ve come out ahead more times than we’ve lost.

Take a look at the track record we’ve been able to achieve so far in the table below:

Aside from a few road bumps, our path to success has been very profitable. In fact, my readers and I have made an average return of 14.5% on our trades so far, and our average holding period stands at just 40 days — that’s good for a 132% annualized return.

The bottom line is, if you’ve never considered using call options as a way to amplify your gains, now is a great time to start. I’ve put together a short presentation that explains how options work and more details on how my Profit Amplifier readers and I have been able to achieve our record of success. If you sign up for my newsletter, I’ll also send you five special reports that will help you get started, including a Brokerage Guide, an Options 101 course and my special “Black Book” of trading secrets. To learn more, simply visit this link.