ptions provide great up or down strike prices
position management and depending on whether the trade is
risk control potential when a long using calls or short
using them to trade the market employing put options.
directionally. This goes beyond
the simple fact that a long Here's a recent example from the
position in a call or put option author's own trading.
has an absolute maximum risk
equal to the cost of the option A long position in Seagate
(plus commissions, of course). Technology (STX) was initiated
That, in and of itself, is a very when the stock was trading at
useful thing. What this article around 21.50 using the March
discusses, however, are a couple 22.50 call options. They were
of handy little things one can do purchased for $0.80. The market
while holding an option position rallied over the next few weeks,
to maximize the return and keep eventually moving up above $24.
the risk well constrained. At that point, a roll-up was
executed by selling the March
Roll Up/Down 22.50 calls at $2.60 and
purchasing the March 25 calls at
Most traders are familiar with $1.40. This action served two
the concept of a trailing stop purposes. The first is that it
whereby one moves their took $1.20 off the table,
protective exit as the market reducing the portfolio exposure
moves in favor of the trade. This and freeing up cash for use
is used to lock in profits. The elsewhere. It also locked in a
same thing can be accomplished profit of $0.40 ($2.60 sales
when one is trading options price minus the $0.80 purchase
rather than the underlying. This price for the 22.50 calls minus
is done by rolling one's position the $1.40 purchase price for the
new 25 calls). At the same time, Roll Forward
it had no effect on the remaining
upside potential for the trade. One of the issues with options is
The two strikes would probably the limited duration they provide
profit about the same from any for holding trades. If one is an
further appreciation in the price intermediate to longer-term
of STX shares. trader, this can be an important
hurdle. That said, however, in a
If the portfolio exposure was manner similar to the roll
deemed acceptable at $2.60, an up/down, if one wants to extend
alternate course of action would the holding period of a position
have been to sell the March 22.50 it can be done by rolling forward
calls and not take any money out, the expiration month.
but rather roll it all in to the
March 25 calls. For example, if Continuing with the STX example,
the position was 10 options, we can look at rolling forward.
selling the 22.50s would net That would be accomplished by
$2600. That cash could have been going from the March contract to
used to purchase 18 of the 25 the June one. As of this writing,
calls ($2600/$140 = 18.57). By the March 25s are trading at
doing so, one actually increases $2.40 and the June 25s are at
the upside potential for the $3.60. There's the rub, though.
trade substantially. Of course, Because of the longer time to
the full position is at risk, expiration, the June contract is
meaning one could theoretically priced significantly higher. That
lose the whole $2600 invested, is why a roll forward is often
which is more than could have best accomplished with a roll
been lost when the trade was up/down.
first initiated.
Consider the earlier roll-up in
STX from the 22.50 call to the 25 depends on the anticipated
call. If we were still in the holding period for the trade.
former, and wanted to both roll
forward and up, we could jump to The rolling of strike prices and
the June 25 call. The current expiration is something easily
price on the 22.50 option is accomplished. The transaction
$4.10. With the June 25 at $3.60, costs for options trades have
we could accomplish both the roll come down substantially for the
up and roll forward and take individual trader in recent
$0.50 off the table. That is not years. That opens up a great many
quite as much as we accomplished possibilities for playing the
with the roll up, but it does market directionally and managing
extend the time we could hold the positions efficiently.
position by three months. Whether
that is worth the trade-off
About the Author:
John Forman is author of The Essentials of Trading (http://www.TheEssentialsofTrading.com) and a near 20-year veteran of the markets. For free trading reports, visit http://www.andurilonline.com/free-stuff.asp
Read more articles by:
John Forman
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