"Options" is the buzzword on many investors' lips these days because the eye-popping returns investors can generate are pretty hard to ignore. Once considered a mainstay of the professional trader's game plan, options trading have now popped up on the radar of the individual investor.

But can a market-maker run out of options? In a word: No. As long as there is a buyer for every seller and vice versa, trades can be made practically into perpetuity. And the single best way for a long-term investor to really pump up their profits is to buy options instead of buying the stock. That's because options—both on the up and down sides—can magnify tiny little movements in a stock's purchase price to hand investors gains of more than  50%–100%... if you play your cards right.

Options Trading—Red-Hot Right Now!

Trading options is red-hot right now with options trading volume up 25% and breaking new records every year. And, honestly, it makes a lot of sense. That's because trading options gives investors the best shot at making much more money in a volatile market like this one. No wonder trading volume is higher than ever.

In fact, the potential of making double-, triple-, even quadruple-digit returns is the #1 reason why both professional and individual traders are drawn to the options markets. And who can blame them?

In-the-Money-Calls

It pays to have exposure to the market at all times. That's why buying cheap options is the perfect way to go. One way to do this is to use stock options, and cheap options can give you an outstanding bang for your buck, or good downside insurance when you buy puts.

You can also use options as a replacement for purchasing stocks, and get far more leverage and far less risk as you participate in the stock market. This strategy protects you from the risk of a crash in the market, as long as you don't go overboard.

To use options as surrogates for stocks, you must usually purchase in-the-money calls (the stock price is above the strike price) that have minimal time value.

But in-the-money options are expensive. When dealing with more expensive stocks, you will have to pay from 5 points to 10 points ($500 to $1,000) for in-the-money options. This opens you to the risk of the stock having a sharp correction and taking most of your option's value down with it.

The Keys to Buying LEAPs

To protect yourself somewhat from this, you can buy an out-of-the-money LEAP, which is a long-term option that can last for up to two and a half years. This large amount of time helps the option price hold up better during a stock decline.

But a LEAP is more expensive than a shorter-term option. So when you buy a LEAP, it is very important to set a mental stop loss on the underlying stock.

If the stock closes below this stop loss, sell the LEAP. This will usually protect you from losing much or all of your option premium if the stock declines. Letting time and money slip away is a major sin of option buyers.

This stop loss should be a "trailing stop." As the option increases in price due to a rise in the stock, you keep moving the stop loss up so that it is never more than five percent below the stock price. But if the stock price declines, you do not adjust the trailing stop. This way, if the stock declines from its high, you will be able to sell the LEAP in plenty of time to preserve most of your profit.

Also, LEAPs tend to lose their value quickly in the last six months before their expiration date. So if you own a LEAP that is out of the money when it moves into its final six months of life, you should strongly consider closing your position.

Another key to buying LEAPs and in-the-money options is to make sure that you are paying a fair price. These options cost more than short-term, out-of-the-money options, so your risk in the event of a price collapse is greater. The less money you have on the table, the less your risk will be.

The #1 Key to Buying a LEAP? Make Sure to Pay a Fair Price!

Make Bullish Bets for Less Risk

Time is another key to success when investors buy options. Now, LEAP options buy you a lot of time, in some cases more than two years. And stocks can make gigantic moves over this time period.

The major problem with long-term options is that they are usually quite expensive. One way to get around this higher cost is to use a vertical debit spread. A debit spread involves selling an option to offset some of the cost of the option you are buying, but it still has the same limited risk as if you had simply bought the option.

The word "spread" seems to scare some options players, but a debit spread is really quite simple.

For example:
You might be interested in buying a Jan 2006 25 Call on a stock recommended in InvestorPlace. But you find that this LEAP is actually quite expensive. To offset some of the cost, you could also sell a Jan 2006 35 Call at the same time. This creates a "vertical" debit spread that effectively reduces the cost of the 25 Call.

Your total risk with this a debit spread is the cost of the spread. So from a risk standpoint, opening a debit spread is exactly the same as buying an option.

But unlike buying an option, your potential profit with a debit spread is limited. Once the stock crosses the higher strike price, the gains from the option you bought are offset by losses from the option you sold. In our example, once the stock crosses 35, the gain in the 25 Call will be offset by a loss in the 35 Call.

The total profit potential with a debit spread is the amount of the spread minus the cost of the spread. So for our example, if the cost of the spread was 2 points, the total profit potential is 8 points (35 minus 25 equals 10, minus 2 equals 8). So the potential return would be 400%.

Debit spreads usually don't generate maximum profits until expiration or the options move deep in the money (in our example, if the stock moves well above 35). So if the spread generates a 100% gain in the first few months, it is a good idea to close half your position and take some money off the table.

If the stock moves against you in a debit spread, another good tactical move is to buy back the option you initially sold if it has lost most of its value. Then you will own the long-term option without the profit limitations of a debit spread.

For example:

If the stock in our example fell instead of rallied and the 35 Call fell to a couple tenths of a point in value, you could buy that option back and then own the 25 Call with no limit on possible gains.

Debit spreads might sound confusing to new option players. Also, they are more of a "slow and steady" road to profits instead of the quick hits that buying options can provide. But once you become familiar with how debit spreads work, they likely will become one of your favorite trading strategies!

Get in the Options Game in 2008!

There are a lot of folks who spend a lot of time identifying bargain options. It's a true calling for many of them, and frankly, a hard talent to master.

One of these guys who taught me a lot about the confusing world of options is Ken Trester. Ken started trading options when the markets first opened way back in 1973. As the nation's foremost professional options trader, Ken isn't just another "options educator"— he puts his money where his mouth is and actively trades his own account. What I also like about Ken is that he recommends low-cost, underpriced options. In other words, he's really good at "buying low and selling high!"

It's a simple theory, but you know all of us at the Confident Investor like to keep things simple—especially when there's lots of money to be made!

Trading options used to be Wall Street's best-kept secret—a strategy used by the pros to pump up their returns and fatten their bank accounts. But in recent years—as investors became better educated and the universe of available options grew—trading volume has exploded.  And why not?  It's the single-best way to control a big block of stock for a very small amount of money because you don't need to start rich to get rich trading options.
If you're not trading options as part of your overall investment strategy, you're being left behind in the hunt for big profits! Learn how to start trading options today with Ken Trester's free online seminar Hitting Home Runs With Options!