[Options] Using Vertical Spreads to Manage Long Call Positions, Part 2. #BallersOnly
This is something that I employ RARELY, and only when the all the stars are perfectly aligning. And I mean everything is lined up -- the technicals, low volatility, blue sky all-time highs ahead, a story, and a potential catalyst on the horizon. I know the last two items might give JC pause (funnymentals? bahhhhhh!!). Like I said, I rarely employ this strategy. Maybe once per year. But when it works, it WORKS. However, I have to be willing to risk large open profits evaporating to nothing, and that is much harder than it sounds -- I promise you.
Let's say I'm incredibly bullish on stock XYZ at $43/share for all the reasons I listed above. Great, time to take my initial position. And when volatility is very low and I'm bullish, my go-to play is to simply buy straight long calls.
Currently we're in October, so I'm going to look for long calls in an expiration 6-12 months out. I'm going to choose June 45 strike calls. So I buy 4 of them at $2.50 each, risking a total of $1,000. (these are all hypothetical figures, btw)
As I hoped, XYZ starts moving higher, passing through my 45 strike and trading up to 46. This is where the process kicks in.
When the stock passes through my long calls strike (45), I then use a vertical roll to sell-to-close my four 45 calls and buy-to-open four 50 calls (the next available strike higher) in the same June expiration. This trade results in a net credit. Let's say that roll was done for $1.50, or a $600 credit (1.50 x 4 calls x 100). But I'm not done!
I then take that $600 credit and purchase as many additional calls at the new 50 call strike as it affords. If the 50 calls are trading at $2.50 each, then I would purchase two more for a $500 debit, bringing my total position to six 50-strike June calls, and leaving $100 behind to reduce my original risk in the position. I originally risked $1000 when I bought my first 4 calls. Now my net risk is $900 and my position is bigger.
As XYZ moves higher through successive strikes, you'll notice that each roll affords me the ability to increase my position size while simultaneously reducing my original capital risk, if only slightly. Of course, as the position gets larger, I'll have rapidly increasing open profits risk, but I can't get a MONSTER win without being willing to risk the house's money. This is how it's done.
Now, the true art is deciding when to take profits. As I'll reiterate, sitting on a large open profit sounds wonderful, but it's literally one of the hardest things for traders to do. Unfortunately, I don't have a one-size-fits-all answer here. If I've managed to keep my emotions and fear/greed in check, there are two options that I usually consider:
Option 1 is to have a price target in mind for the stock. So, if I got in when XYZ was 43... maybe I'm looking for the stock to double in price to 86 (remember, I'm INCREDIBLY bullish on this stock, so a 100% move should be a minimum target). I would then either close the entire position when this price target has been reached, or I'll begin aggressively taking profits and sizing down the position.
Option 2 is to ride it all the way into the expiration month, come-what-may, and close it near the beginning of the month (in this example, I'd head for the door on June 1st).
Again, this is an AGGRESSIVE strategy and not one that I employ often. And when I do, it often doesn't work out as I'd hoped. But sizing the original position to a level of risk I'm comfortable risking keeps everything in line, and if I get at least a couple rolls done, at least I was able to reduce my original capital risk somewhat.
Feeling lucky? Try it yourself next time you see the stars align on a stock you like. Hit me up on twitter if you'd like to discuss more.
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