Warren Buffett is arguably the most successful investor in history. He is the epitome of a value investor. He is, without a doubt, one of the smartest investors this world has ever known. How can you argue with a man about the investment philosophy that made him #2 on the Forbes 400 list (second to Bill Gates)?

But I must confess: I am probably not as savvy as Warren Buffett. No, really, folks. I know it’s hard to believe . . . I know that many of you probably disagree with me . . . But I have thought long and hard about this one. While I am close with some of the savviest value investors of our time, I would probably be less successful at picking the stocks that will show you the highest consistent returns over a 20-year period. When Buffett battles the market, in time, he wins.

I enjoy making huge gains on quick trades and I love showing you how to do the same. By “quick” I mean as little as five days, to six months. Sometimes I can manage to hold a stock for a few years while I either sell calls on the position, or use strategies that are much more complex than that. But if you take some time to learn about these methods, they really are rather easy. I never go crazy with 20-30 different stock or option positions. I simply pick a few easy plays. I keep it simple. Why take the risk?

Here’s a money-making philosophy: The stock market is a monster that is bigger than I am, stronger than I am, has been around longer than I have, and is still much faster than I am. Not to mention that I can remember a couple of times when it kicked my butt.

So what do I do? I make sure that before I go to battle against a monster that big, I find an advantage. I significantly reduce the power that the stock market has over the capital that I put at risk in order to make my profits. Also known as hedging! Reducing the power of the stock market. Or disarming the market! There are several ways of reducing the power of the market, some more complex than others. Would you like to know how?

Here’s a good example:

Last Wednesday I was trying to illustrate a point that buying a call is not as risky as some people think. In a sense, it can actually reduce your risk. When describing my latest play last Wednesday, I listed eight specific characteristics of the company I had an appetite for, and while I did not show you all of my cards, I gave you more than enough information to figure out what stock I was talking about if you were ambitious enough. (I'll describe another one for you next week.)

I guess I could have given my valuable secret away. But over the next few weeks I hope to give you something of greater value. You see, I’d rather teach you to fish……

I mentioned a generic drug maker on the NASDAQ that was trading at $42.04. The option contract that I was talking about which was the October $42.50 call at $2.80 more than doubled two days later, and still sits today, at 5.90. The stock is at $46.48. I had several choices on how to play this.

·  I could sit on my hands. The risk here is the $2.80 which is the original cost of the option contract. If the stock trades lower, and stays lower than $42.50, the option contract could completely diminish in value.

On the upside, the profit potential here would equal the difference between the $42.50 strike price and the dollar amount that the stock trades over $42.50 (for example: if the stock trades to $52.50, I could sell the call option contract at $10 per contract).

·  I could be a seller at these prices, with the contract 100% higher. Not a bad trade in one week.

OR - I could always HEDGE the position.

Here’s how YOU can do it:

You can turn what started out as the simple options play of owning the call (which is the right to buy the stock at a certain price – in this case $42.50), into what is called a “straddle.” This is generally the ideal strategy if you think a stock will have a big price swing, but you are not sure if it is going to be on the upside, or the downside.

A “straddle” is simply the purchase or sale of an equal number of puts and calls having the same terms. So in this example, you would own an “October 42.50 Call” (the right to BUY the stock at $42.50, which is a contract that expires on the third Friday of October).

You would create a “straddle” by purchasing the exact same number of “October $42.50 Puts” (the right to SELL the stock at $42.50, which is a contract that expires on the third Friday of October).

So far you would have paid $2.80 for the October $42.50 Call option, last week. If you decided to buy the October 42.50 Put option, you would have paid about 1.10. So your total cost would be the sum of $2.80 and $1.10 which is $3.90

WHAT IS THE RESULT?

Here your total risk would be that $3.90. The only way that you could possibly lose that $3.90 is if the stock were to close at exactly $42.50 on the third Friday of October. Assume that the total “entry price” here was $3.90. Your “exit price” would simply be the difference between $42.50 and the price of the stock when you decide to close out your position.

In other words, the stock can trade up, or down. Whichever direction it decides to trade, your exit price will be the difference between the current price of the stock and the “strike price” of $42.50. Another way of looking at it is that as long as you close out your position in the next 72 days, if the stock is over $46.40, or under $38.60 you are profitable.

Remember the stock is already at $46.48 and climbing. If the stock trades to $12.50 you would have a $26.10 profit. If the stock trades to $70, you would have a $23.60 profit.

The Bonus: If you take some time to learn to hedge yourself, you might even live longer!  Rather than sitting at my desk all day long trying to accurately pick the direction of the market consistently, I’m going fishing.

See you next week.

 (Note: It is important to note that each option contract represents the right to purchase 100 shares of stock. If a trader bought one option contract at $5 per option contract, the total cost would be $500.00)