by Tyler Craig | September 13, 2011 1:50 pm
The hardest trading decisions typically arise when facing an “all or nothing” choice. Take a profitable long stock position, for example. Selling the entire position allows you to capture all of the current gains, eliminate any risks associated with the positions, and free up trading capital that can be put to work elsewhere. The principal drawback to such a decision is sacrificing the potential to capture any additional gains.
On the other hand, remaining in the position allows the accumulation of additional gains while subjecting you to the risk of giving back unrealized profits. Both courses of action involve alluring trade-offs, further increasing the difficulty of making a decision.
To combat this dilemma, savvy traders inject a dose of compromise into the mix. They scale out by taking partial profits. For example, if they own 100 shares, they may sell 50 shares after reaching a profit target. Such a decision is easy to make as it partly accesses the advantages offered by both decisions.
The options market presents a number of other alternatives for compromise. One such technique available to profitable call-option owners is “rolling up”.
Suppose you purchased an Amazon (NASDAQ:AMZN) October 205 call option for $12 early last week. The delta of the option, its rate of change compared to the price rate change of the underlying stock, was 40 at trade inception. Concurrent with the climb in Amazon’s shares in recent days, the call option has risen in value to $19 giving you an unrealized profit of $700. In addition, the delta on the option has risen to 65.
Let’s say you’re still bullish, but you’d like to reduce your directional exposure and capital tied up in the position. How about rolling up the call to a higher strike price such as the October 215 call? You do this by selling to close the Oct 205 call while buying to open the 215 call. Of the $19 brought in by selling the Oct 205 call, $12 would be spent on the new 215 call. The adjustment would effectively capture $7 of the gain while placing you in a new call option trade — boasting only $12 of risk and a delta of 46.
The beauty of rolling up is that you have a variety of strike prices to choose from, allowing you to customize the remaining risk in the position. Remember this technique next time you’re wrestling with how to best manage a profitable long call option. Rolling up often strikes the right balance between minimizing risk and maximizing gains.
At the time of this writing, Tyler Craig had no positions on AMZN.
Source URL: http://investorplace.com/2011/09/how-to-lock-in-part-of-your-call-option-profit/
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