Ride Silver with a Stock Replacement Strategy

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Maximize gains and minimize losses has long been touted as the overarching objective for traders of all stripes. While options trading investors have their ups and downs in the short run, profitability in the long run requires the ability to contain losing trades while allowing profitable trades to continue to perform. Achieving this feat is easier said than done.

Though all market participants hope a profitable trade turns out to be the gift that keeps on giving, fear often causes emotionally driven traders to bail out too early only to see their stock of choice continue rising without them. After a stock has climbed a considerable amount, the temptation to exit can sometimes be overwhelming. Take the iSHARES Silver Trust (NYSE: SLV) for example. Over the past five weeks it has risen a staggering 32%, giving its owners a hefty unrealized gain. Many of these traders face a dilemma — sell to lock in the profits or stay in to potentially capture additional gains?

 

iShares Silver Trust

iShares Silver Trust

Instead of tormenting yourself by arguing the superiority of either decision, how about making a compromise by using what’s known as the stock replacement strategy? The gist of this strategy is to replace the long position in the underlying (let’s assume you own 100 shares) with some type of option play which maintains your exposure to further upside in SLV while drastically reducing your potential risk. Consider the following two ideas:

— Sell SLV and replace it with a long call option. Which expiration month and strike price you select ultimately depends on your time horizon and how much exposure you seek. Those looking to have continued bullish exposure over the next four months may consider purchasing a SLV July 33 Call option.

— Sell SLV and replace it with a long call spread. The call spread offers a cheaper, limited reward alternative to the long call option. Since the spread involves buying and selling options, it also reduces your exposure to both time decay and volatility. Consider the purchase of the SLV July 33-40 Call Spread. That is, purchase the SLV July 33 Call, and sell an equal number of contracts of the SLV July 40 Calls.

If SLV were to fall from its lofty heights, both option positions offer much less directional exposure than a 100 share SLV position.

Follow Tyler Craig on Twitter@TylersTrading.

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Article printed from InvestorPlace Media, https://investorplace.com/2011/03/ride-silver-with-a-stock-replacement-strategy/.

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