by Tyler Craig | July 20, 2011 11:56 am
The call vertical spread is a weapon of choice for many option trading enthusiasts. Its structure consists of purchasing a lower strike call option while selling a higher strike call option in the same expiration month. For example an Aug 100-110 call spread would consist of buying to open the Aug 100 call and selling to open the 110 call. Since traders are both buying and selling options the position offers reduced exposure to both time decay and volatility.
When faced with a profitable position, traders must tackle the fortunate dilemma of deciding when to take profits. The problem is that traders usually want to let the position ride to maximize their gains, yet they don’t want to give back hard earned profits if the stock moves adversely. The decision can be more difficult than meets the eye. One adjustment that can help solve this dilemma for profitable call vertical spreads is rolling up. Let’s use an example on Apple (NASDAQ: AAPL) to illustrate.
Suppose you originally purchased a AAPL Sep 350-380 Call Spread for $10. Given AAPL’s rise to $390 the call spread currently has a value of $22 leaving you with a $1,200 unrealized gain (see Figure 1).
To both reduce risk and still have the potential to capture more gains if AAPL continues to rise, we could close the 350-380 spread and open up a AAPL Sep 380-410 Call Spread which currently costs about $13 (see Figure 2).
By rolling up we’re essentially selling the more expensive call spread and using part of the proceeds to finance the purchase of a cheaper call spread with higher strike prices. The same technique can be used with long call options which have moved deep in-the-money and risen significantly in value. Traders can simply sell them and purchase a cheaper call option with a higher strike price.
If you’re an active option trader and have yet to explore rolling up, consider this your invitation. It can be a very effective technique for squeezing more gains from your winners.
(Graphics provided by MachTrader).
At the time of this writing Tyler Craig had no positions on AAPL.
Follow Tyler Craig on Twitter@TylersTrading.
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