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Weighing Risk When Trading Options

What does the NFL Draft have to do with options trading? Actually, more than you might think.

Sparklers and Champagne Glasses

If you’ve ever rooted for a bad football team, you know that the next year’s draft is essentially that team’s Super Bowl.

And as a long-suffering Chicago Bears fan, I’ve had more than my fair share of years with picks right near the top of the draft.

They’ve never quite panned out how I hoped. But this time, maybe, just maybe, the Bears would end up with a starting quarterback to take them to the promised land.

This year the Chicago Bears had the number one pick in the NFL draft and there was no question the team was going to draft Caleb Williams who is thought to be a generational talent at quarterback. I am soooo excited as I’ve paid virtually no attention to the team for years, as the team has not been interesting, or competitive.

Now, the first overall pick comes with a ton of baggage. The most obvious of which is the boom or bust potential of the pick. The right pick can change a franchise’s fortunes, the wrong pick is immediately at risk of being a bust, even if the player is otherwise solid.

And while the Bears pick was thought to be a no-brainer (again, generational talent), it got more interesting a couple picks later when fellow Cabot Analyst Mike Cintolo’s New England Patriots were picking at three.

Mike and I debated what the Patriots should do with that pick for months as it was a slam dunk the Bears should pick the best quarterback at one, but it got a bit cloudier at number three, as the talent pool dropped off a bit.

My thesis on this subject was that the Patriots had to take a quarterback at three as the reward in picking the next great passer was too good to pass up.

Mike vehemently disagreed and said the bust potential, and history of drafting quarterbacks that failed, could hurt the team for years. Mike wanted the team to trade back and amass several draft picks to rebuild the team.

Now, when it was all said and done, the Patriots’ front office sided with me, drafting quarterback Drake Maye out of North Carolina and maybe giving the Patriots their next franchise quarterback. Time will tell.

So what does this have to do with investing?

I’m an options trader, and what I do all day every day is price risk.

For example, if the market is strong, and hedge funds and institutions are buying calls in a stock, and if I can pay $200 for a call buy and potentially turn that capital into $1,700, that is a risk/reward I like.

However, I also know that should things go wrong, in the options game, that $200 can go to zero.

That is like drafting a quarterback, it could be a wild success or a complete bust.

For example, last month I recommended to subscribers of Cabot Options Trader a buy of Freeport McMoran (FCX) calls, and shortly thereafter a buy of calls in the Gold Miners ETF (GDX). These purchases were made not because I’m a copper and gold bug, but instead because the call buying in these stocks and sectors by hedge funds was overwhelmingly bullish.

And to pay $590 for FCX calls, and $450 for GDX calls, with unlimited upside potential, was in my mind a risk/reward worth taking, as these commodity stocks can get VERY hot, VERY quickly.

However, in my trade alert to buy both sets of calls, I did warn my subscribers that commodities, and these stocks, can also get cold VERY quickly, so there was risk.

That being said, I’m a home run hitter, and much like the NFL draft when it comes to options trading I’m not here to play it super safe … and when there is an opportunity that is too good to pass, up I pounce.

Jacob Mintz is a professional options trader and editor of Cabot Options Trader. Using his proprietary options scans, Jacob creates and manages positions in equities based on unusual option activity and risk/reward.