Options present excellent position management as well as risk management opportunities when using them to trade the market directionally. This goes way beyond the fundamental point in which a long position in a call or put option provides a complete maximum risk equal to the price of the option (in addition to commissions, naturally). This alone is very useful. What this article covers, however, are some useful little things you can do while keeping an option position to improve the profit and keep the risk well constrained.
Roll Up/Down
Almost all traders are familiar with the concept of a trailing stop where someone changes their protective exit as the market changes in favor of the trade. They use this tactic to lock in revenues. The same thing may be accomplished when one is trading options rather than the underlying. This is done by rolling one's position up or down strike prices depending on whether the trade is actually a long employing calls or short employing put options.
Below is a good example of a case study:
A long position in Seagate Technology (STX) had been initiated when the stock was dealing at around 21.50 based on the March 22.50 call options. These were bought at $0.80. The market bounced back throughout the subsequent few weeks, finally moving up above $24. At that point, a roll-up had been implemented by selling the March 22.50 calls at $2.60 and buying the March 25 calls at $1.40. This move served two purposes. The first is that it took $1.20 off of the table, cutting down the portfolio vulnerability and allowing for money to be used somewhere else. It also locked in a profit of $0.40 ($2.60 sales price minus the $0.80 purchase price for the 22.50 calls minus the $1.40 purchase price for the new 25 calls). At the same time, it doesn't affect the rest of the upside prospects for the trade. The two strikes would most likely profit comparably from any further increase in value in the price tag of STX shares.
In the event the portfolio vulnerability was considered fair at $2.60, an alternate plan of action might have been selling the March 22.50 calls instead of take any cash out, but instead roll all of it inside the March 25 calls. For example, if the position had been 10 options, selling the 22.50s would likely net $2600. That cash could have been utilized to purchase 18 of the 25 calls ($2600/$140 = 18.57). By doing so, one actually improves the upside possibility of the trade greatly. Of course, the full position is at stake, meaning one could hypothetically lose the entire $2600 invested, which is greater than could have been lost when the trade started.
Roll Forward
One of many problems with options is the limited duration they provide for keeping trades. If you are an intermediate to longer-term trader, this could be a significant hurdle. That said, however, in a style just like the roll up/down, if one desires to lengthen the holding time period of a position it can be done by rolling forward the expiration month.
Continuing with the STX example, we are able to take a look at rolling forward. That could be achieved by going from the March contract to the June one. As of the time of this writing, the March 25s are trading at $2.40 and the June 25s are at $3.60. There's the rub, though. As a result of lengthier timeframe to expiration, the June contract is priced significantly higher. This is why a roll forward is normally best accomplished with a roll up/down.
Take into account the prior roll-up in STX from the 22.50 call to the 25 call. If we were still in the former, and wished to both roll forward and up, we could jump to the June 25 call. The present price on the 22.50 option is $4.10. With the June 25 at $3.60, we could execute both the roll up and roll forward plus take $0.50 off the table. That isn't close to what we accomplished with the roll up, however it does lengthen the amount of time we're able to hold the position by three months. Whether or not that is really worth the trade-off depends upon the expected holding period for the trade.
The rolling of strike prices and expiration is something effortlessly executed. The transaction rates for options trades have decreased greatly for the individual trader in recent years. That uncovers a great many possibilities for playing the market directionally and also managing positions successfully.
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