At tastytrade, we are all about cost basis reduction. The only way to reduce our cost basis is to limit profitability. By limiting profitability, we increase our probability of success. Reducing cost basis continually in long stock positions, allows us to generate capital and improve our probability of success in sideways markets.
For example, if we buy 100 shares of stock for $500 in a random environment, our probability of profit will average out to about 52%. If we limit our profitability and sell a call against it for $25, this creates a covered call position. In doing so, we reduce our cost basis to $475 for the 100 shares of stock, limit our profitability and increase our probability of success. Our studies show that reducing our cost basis every month significantly increases our annual return on capital as well as our probability of profit.
At tastytrade, we will always reduce our cost basis whenever we can. We will do this when buying stock as well as buying debit spreads in low volatility environments. Instead of buying a naked call for example, buying a call spread increases our probability of profit and reduces our cost to enter the trade significantly. We believe in giving ourselves the best opportunity for success as possible, and reducing our cost basis does just that.
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