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So what are we saying here? Something that was created to reduce risk offers opportunities for tremendous profits? Higher profits always come at the expense of higher risks, don't they? Not necessarily! The secret lies in the definition of risk and in the use of leverage.

The use of options is a little like buying lottery tickets. You bet only a few dollars for the opportunity of winning a large amount of money. You know that your chances of winning the lottery are very small, so you bet only small amounts of money at a time. If you win, however, the payoff is huge. This is what options are all about...risking a small amount and controlling hundreds of thousands, perhaps millions, of dollars worth of assets.

The most common example of using options is the case of writing a small check to hold a house you may wish to buy. In this example, you demonstrate your willingness to buy the property by committing a relatively small amount of money to the realtor. In most cases, the money isn't really at risk because it will be refunded to you if you decide to buy the house or release the property before the agreed upon deadline. Although buying and selling stock options is not quite as customer friendly, the idea is the same.

Let's suppose you are interested in buying 1,000 shares of XYZ at $30.00 per share but do not have the funds to make the purchase. There are at least two ways of buying this stock without immediately spending the required $30,000, (for simplicity we will not include commissions in our examples). You can buy the shares on margin, or you can utilize Call options. In either case you would need to have a margin account with your broker. (Margins accounts are discussed in Appendix I.)

If you decided to buy the shares on margin, you would pay $15,000 in cash, and borrow $15,000 from the broker. This choice gives you ownership of the shares for only half the purchase price of the stocks. It also gives you all risks and benefits that go with ownership. The risk, of course, is that the price of the stock could go down and you could lose the entire $30,000 plus commissions and interest on the broker's loan. Incidentally, the broker would make a margin call if the stock had gone below $20.00 per share. This means that you would have to sell some of the shares you bought or send the broker more cash to cover some of your losses. This is not a happy scene.

The benefit of using margin is that the price of the stock could soar, and all of the profits at the rate of two dollars per dollar of cash invested less the interest on your loan would go to you. Better yet, the broker would be willing to lend you more money as the price of the stock went up. Wow! There is no limit on how much you could make.

If you decided to use options, you could have bought 10 Call Options to control the 1,000 shares of stock. These options could cost as little as a few thousand dollars. Call options do not give you ownership of the stock, but they provide the right to buy the desired number of shares, (1,000), at a specified price, ($30.00 per share), by a certain date which you would specify. An "at-the-money" option," with average volatility, (30%), expiring in six months would normally cost about ten percent of the strike price, ($30.00). In this case, your cash outlay would be $3,000.

The risk here is that you could lose the entire $3,000, a relatively small amount compared to $30,000. Another problem is that the price of the stock would have to go to above $33.00 per share for you to make money. The benefit is that if the price of the stock does go above $33.00 per share, you start to make a profit. Let's say that the price of the stock was $45.00 per share at expiration. You could sell your Call options for $15.00 per share, for a total of $15,000. Your gain would be $12,000 and your percent gain on cash invested would be 400.0%. Not bad. Had you purchased the stock for $30,000 and made $15,000, your gain would have been 50%, which is still quite good, but a far cry from 400%. Moreover, let's not forget that you didn't have the $30,000 in the first place, so you couldn't even have made the trade!

Some option fanatics can't understand why anyone would ever trade stocks. But trading options is not that easy. There are a whole lot of things you've got to know in order to consistently make money in options. Although there are only two types of options, Calls and Puts, they can be bought or sold to open long or short option positions, close long or short option positions, or exercise long or short option positions. Options can be bought or sold above, below or at the option Strike Price, with just a short time or up to three years to expiration, and in combination with other stocks and/or options.

There are an infinite variety of trading decisions which can be made when using options. Although this flexibility is another major advantage to using options, it adds complexity. The simple example shown above is just the tip of the iceberg to using options. In this report, we will explore only a few relatively safe but profitable strategies for supercharging your investments.

There are two types of options: Calls and Puts. Call options provide the right, but not the obligation, to buy units of 100 shares of stock at a certain price by a certain date. Call options increase in value when the price of the underlying stock goes up.

Objectives: Call options are purchased to achieve one or more of the following objectives:

1. To reduce risk,
2. To gain leverage on buying high priced stocks,
3. To hedge a short position, and
4. To play a market rally by using Index options.

Considerations: When buying Call options, one should be aware of the following considerations:

1. The market outlook is bullish,
2. VectorVest's Market Timing Indicator is rising,
3. Risk is limited to cost of the option position,
4. Reward is unlimited as the stock price increases above break-even,
5. The break-even price equals the Strike-Price plus the option Premium,
6. The preferred Strike Price is at or below the current stock price, and.
7. The preferred expiration date should be out far enough to allow the stock price to rise well above the break-even price.

Applications: Given the objectives and considerations cited above, the following VectorVest searches, sorts and strategies are suggested for buying Call options:

1. High VST-Vector stocks sorted by RT,
2. Hot Stocks in hot industry groups,
3. Hot new highs,
4. Hot W*O*W WatchList Stocks,
5. Bottle-Rocket stocks,
6. Explosive Breakout stocks,
7. Great Growth stocks.

Case Study: On October 11, 2002, VectorVest said, "The Price of the V V C hit a low of $14.08 on July 23rd, and a lower low of $13.21 on October 9th. The MTI hit a low of 0.34 on July 23rd, and a higher low of 0.40 on October 9th. This bullish divergence gives me some confidence that the two-day rally may be sustainable. If the market is still in a rally mode on Monday, Prudent Investors may buy some high VST-Vector, "B" rated stocks. Aggressive Investors should play the market to the upside."

Indeed, the outlook was bullish. The market was moving upward, and the MTI was rising. It was time to buy some Call options. If one had simply gone to Stock Viewer and selected the top optionable stock, sorted by RT, they would have found American Pharm, (APPX), selling at $17.99 per share.

The Dec., 20 Calls were selling for about $0.85 cents per share. You could have purchased 10 contracts of these Call options, which control 1,000 shares of stock, for about $850. The stock soared to 23.58 per share on November 11th, and the Dec., 20 Calls were worth $2.60 per share, up $1.75 or 206% in 17 days. Not bad!

The next highest optionable stock ranked by RT, was Primedia, selling for $1.69 per share. At this low price, you may not have considered buying Call options and done very well. The stock closed at $3.40 on 12/02/02, up 100%. Let's see what you could have done using Call options.

The Dec., 2.5 Call was selling for about $0.10 per share. You could have purchased 100 contracts, which control 10,000 shares of stock, for $1,000. On 12/02/02, these Calls were worth about $0.90 per share, up 800% or $8,000 in a little over seven weeks. Now that's what I call hitting the jackpot!

Put options are definitely used to reduce risk. They work the same way insurance does by guaranteeing that you will receive a certain value for an underlying asset even if it goes down to zero. Put options can appear to be expensive compared to home or auto insurance, so they have to be used judiciously. A good example of this came back in March of 2000 when we were recommending that investors take and/or protect profits on long positions.

An old friend had several thousand shares of Intel with a very low cost basis. He didn't want to sell the stock and pay the capital gains taxes so I advised him to buy Put options. He then complained that the Put options were too expensive. So I advised him to sell out-of-the-money Calls, (the Strike Price of the Calls were well above the stock price), to help pay for the Puts. This setup of a long stock, short Call and long Put is called a Collar. He did it and saved himself a lot of money.

Since Puts go up in value when stock prices go down, they can also be used as an alternative to selling stocks short. A major advantage of using Put options as compared to selling-short is that your risk is limited to the cost of the premium for the Puts. The risk in selling stocks short is unlimited. Let's see what this is all about.

Objectives: Put options are purchased to achieve one or more of the following objectives:

1. To reduce risk,
2. To use as an alternative to selling short,
3. To hedge a long position, and
4. To play a market downturn with Index Put options.

1. The market outlook is bearish,
2. VectorVest's Market Timing Indicator is falling,
3. Risk is limited to the cost of the option position,
4. Reward is limited to the degree the stock price decreases below break-even,
5. The break-even price equals the Strike-Price minus the option Premium,
6. The preferred Strike Price is at or above the current stock price, and
7. The preferred expiration date should be out far enough to allow the stock price to fall well below the break-even price.

Applications: Given the objectives and considerations cited above, the following VectorVest searches, sorts and strategies are suggested for buying Put options:

1. Worst Stocks > $20.00 sorted by VST Asc,
2. Falling stocks in falling industry groups,
3. Stinky Stocks to Sell Short.
4. Seto's Hook and Sinkers,
5. Down Hill Racers,
6. Hold Your Nose.

Case Study: On January 11, 2002, VectorVest said, "As expected, our Market Timing Indicators have been moving downward from their lofty levels. The Price of the VectorVest Composite has gone down on a week-to-week basis, and the rally has now completed its sixteenth week from the September 21st low. It's time for Prudent Investors to get serious about taking profits and reducing long positions. Aggressive Investors and Traders should buy Puts and/or sell stocks short. For those of you who are "Riding the Wave," we are going short with a new strategy called, "Worst Stocks Over $20.00."

Indeed, the market had a blow-off rally ending on 01/04/02 and had started on its long journey downward. Had you run the "Worst Stocks Over $20.00" strategy on 01/11/02 as cited above, you would have found Triton PCS, (TPC), at the top of the list. It was selling for $20.30 per share.

The March 20 Puts were selling for about $1.40 per share. You could have bought 10 contracts, (1,000 shares), for $1,400. The stock fell sharply during the ensuing downturn. On 02/06/02, the stock closed at $8.40 per share. The March 20 Puts were worth $11.55 per share. These Puts gained $10.15 per share, 725%, in eighteen days. Your profit could have been $10,150 on a $1,400 investment.

VectorVest provides a 2-day course that is designed for investors who want to learn options from the ground up. No previous options trading experience is required to attend this course. The course begins with a thorough introduction to options terminology, characteristics and pricing. The six basic building blocks of equity and options trading are presented in detail. The course goes into the application of Synthetics, Covered Calls, Married Puts, Collars, Fences, Spreads of all kinds, Straddles, Strangles, Butterflies, Condors, Iron Butterflies and LEAPS. Each application is illustrated with a P&L Analysis, Case Study and appropriate VectorVest searches. Please call 1-800-231-0110 for more information.

Margin cash indicates the maximum amount of money you have available to open options positions. Buying power indicates the amount of money you have to open long or short stock positions. Margin cash is usually about one-half of buying power. The following formulas are useful in helping to understand how margin cash and buying power are determined:

As we have seen from the above examples the amount of money you have available to spend on opening option positions is always equal to the margin cash. In Case I, the margin cash was the same as the hard cash. Variations of Cases II and III should be explored to see how margin cash changes under different scenarios. You may also wish to do a series of "what if" scenarios in which stock prices go up or down.

It should be made clear that margin requirements in general and margin requirements for options in particular are very complex subjects. The hypothetical cases presented above are child's play compared to the real world. Imagine having a portfolio containing cash, long and short stock positions and long and short option positions all at the same time. Don't try to figure out how much margin cash or buying power you have in your account. Let your broker do it. Every broker has their own set of rules regarding margin accounts, so keep your eye on margin cash and buying power very closely.