This Strategy Session explores a professional option strategy that enables the trader to harvest profits, maintain the same risk profile, and stay in the trade.
The Trader’s Dilemma
Imagine you own $XYZ stock at $100. A month later the stock has run to $115 giving you a nice 15% profit and $15 of embedded gains in your position. Should you hold for more gains and risk a rug pull that may wipe away your gains on some random afternoon or take profits now? That’s the big decision. Most traders would be tempted to sell out. After all, nobody ever went broke “ringing the register”. Actually I disagree. Lots of traders go broke because the small gains from their winners don’t cover all the losses from mistakes and getting stopped out. In order to find longer-term success, its imperative that the trader stay in winners as long as possible. We’ve all been there. Selling out too soon only to see the stock continue on for massive gains without us. Trends – up or down – always last longer than people expect. Just recently $AMZN doubled from $1500 to $3000 in just a few months. $TSLA went from $500 to $1400 over the same period of time. It would make you sick if you sold out for a small fraction of those runs.
What if I could show you a way to remain in your positions, keep your risk profile nearly the same, while harvesting profits all along the way? It’s a strategy I see pros do all the time and it really works. Intrigued? Read on.
On a Roll? Then Roll and Protect!
Here is where knowing how to execute some simple option trades gives you a huge amount of flexibility compared to those trading common stock. This is why many professionals use options to express their outlook. Options offer huge advantages no matter if the intent is to hedge a position or to express a directional bias. There are volumes devoted to the potential strategies traders can employ, but the one I want to share today is a powerful strategy I call “roll and protect” . Don’t be daunted. It is an easy strategy and once you get comfortable with options, you’ll never go back to common. This strategy promises to keep you in winning trades longer, while allowing your to protect your profits and while keeping your risk profile the same.
The “roll up” is a strategy used for call options where the underlying stock price has risen, and there’s a related strategy called the roll-down that’s used for puts when the stock price falls. Conceptually, they’re the same strategy – just used in opposite directions. When you understand one, you’ll understand the other. For now, let’s just focus on the roll-up.
The “Roll and Protect” Strategy explained
Let me walk you through the process.
$XYZ is trading at $50. Rather than buying common stock in $XYZ , you buy a $50 call option 3 months out for $3.00. Because each option controls 100 shares of the underlying 1 call option at $3.00 will cost you $300 instead of the $5000 it would have taken to buy the common shares.
After a month, the stock has risen to $56.25. Now the value of your call has risen. Refer to the table for the option quotes.
You can see your $50 calls are now worth $7.20, over double what you paid. Should you sell out? Remember, trends can last longer than what you think and once you sell out, you won’t be able to participate in any further upside. Instead, let’s “roll” our strikes higher, harvest the gain, and stay long in the trade. How would you do that?
Within most option platforms there is a “roll strategy” option. What happens is that you SELL the $50 calls for $7.20 and simultaneously BUY the $55 calls for $3.20. In the platform, it will show that you will receive a NET CREDIT of $4 per option or in this case $400. At the end of the transaction you will own 1 of the $55 CALLS at $3.20 and will have received $400 credited to your account. You’ve harvested $400 and you are still in the trade and able to participate in further upside. In addition, and this is important, your monies at risk has remained almost the same. $320 now vs $300 for your original position.
Rolling higher ALWAYS produces a NET CREDIT because higher strikes will be cheaper than those in the money. Rolling higher also has an important psychological benefit. Because you basically have the same amount of risk as when you started, the fear of losing is reduced. You are also comforted in knowing you’ve already banked a win.
What about on the PUT side?
You’d employ the same exact strategy except you would be rolling your PUT strikes down instead of up. You will be able to harvest profits as price declines on the underlying.
When should I roll my position?
This really comes down to personal preference. For me I usually start to consider rolling my strikes when I am up 100% or said another way, have a double on the books. I most certainly will have rolled when my original position is up 150% – 200%. At these levels there is simply too much profit out on the table. I want to get that in the bank and ready to deploy elsewhere if I see something I want to shoot at.
Why can’t I just use a stop to manage my risk?
You can and many people do, but remember, one of the main purposes of the roll and protect strategy is to keep you in trades longer with defined risk. If you used a trailing stop and there was one bad day you’d likely be stopped out and out of the trade altogether. Then you’d be faced with the question “Should I get back in?” I like the idea of knowing my risk upfront and sticking with the trend, even if there are bumps along the way.
Pulling it together
The “Roll and Protect” strategy is so powerful. Here is a summary of the strategy
- BUYING at the money calls 3 months out is a great way to conserve your capital compared to buying the underlying common stock
- The strategy allows you to harvest gains along the way and stay in the trade.
- By booking wins as you go, it reduces psychological stress. You more or less have the same amount of capital at risk as you stair step your way higher.
- This is a versatile strategy that can be used when going long or short a stock.
- This is an easy to understand strategy that beginners can use to get started with options. Start slow with 1 contract. Build your confidence with small position sizes.
- Traders may want to explore this definition of the strategy for further clarity HERE
Hope it helps! If you get stuck, feel free to reach out. I’d be glad to review it with you.
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