[Options] Using Vertical Spreads to Manage Long Call Positions, Part 1.
With everything in options trading, there are tradeoffs. In exchange for locking in much of our open profits, we can still participate in any further upside moves, only to a lesser extent.
Let's say back in January 2019 I purchased XYZ January 2020 $65 strike calls for $3.50. At the time, that $65 strike was slightly out-of-the-money as XYZ stock was trading around $62/share. Fast forward to September 2019 and XYZ stock is trading north of $100/share. A HUGE win on paper. My January 2020 $65 strike calls are now worth $40.00 (a 10x return on my money) and are now trading dollar-for-dollar with all moves of XYZ stock, up or down. This is great, but now I'm worried that the stock is showing signs of exhaustion and I don't want to lose any of my paper gains. But I'd be extremely mad at myself if I got spooked for no reason and the stock continued higher towards $150 or beyond.
Here's how to protect my profits and still participate in any further upside:
Consider a vertical roll.
A vertical roll consists of selling my in-the-money options (in this case the 65 calls) and simultaneously purchasing an identical amount of calls at a higher strike in the same expiration series. In this case, I'll purchase the $105 strike calls which are slightly out-of-the-money with XYZ trading at $102/share (hypothetically). The net result of this roll would be a credit in the neighborhood of $35 or so.
What I've accomplished is I've safely tucked away $3500 (one contract controls the equivalent of 100 shares of stock) of open profits per contract, and now the most I can lose from here is whatever I paid for the 105 call -- in this example lets say I bought it at $5. The most I can lose from here is $5, versus the $40 of open risk I had previously. Not bad, right? Now I can sleep easier (I like sleep). But it gets even better... I'm still in position to ride for higher gains into January 2020 expiration! (I like phat gainz too!)
But there's a caveat...
I've swapped WAY in-the-money long calls sporting 100 deltas for slightly out-of-the money long calls with deltas of approximately 40. This means, the magnitude of gains if XYZ stocks continues higher will be smaller for my 105 strike calls, at least in the near term. If XYZ continues to scream higher, the position will gain deltas as XYZ moves higher and higher, eventually getting back to a 100 delta (and therefore dollar-for-dollar gains/losses) if the stocks keeps screaming. And then I can repeat the process again (best case situation).
Another way to do this is to be aggressively conservative with long call positions from the very beginning. This is not a practice I engage in often, but I know a lot of people who successfully roll up long call positions every time the stock trades through the next higher strike. For example, they bought ABC $50-strike calls. When ABC trades up to $55, they then roll their 50 calls to 55 calls, pocketing a credit (approximately $3.00) which reduces their capital risk (or locks in a guaranteed profit) and they continue this process at every strike on the way up. This will result in smaller profits on a big run than you would've gained had you held the original long call position, but for that tradeoff you'll book more steady profits (higher win-rate) and suffer smaller losses on reversals.
There is no right answer here, it simply comes down to what makes you comfortable.
I hope this has given you some food for thought for managing any open paper profits you're sitting on, Rockstar!
In Part 2 (stay tuned), I'll show you a way to use vertical rolls in a similar fashion, but to aggressively roll into HUGE winners (not for the faint of the heart, but a strong power play when you have BIGLY conviction on a thesis).
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