Sometimes the market gives you a problem…
But it’s the kind of problem you want to have.
If you’ve grabbed hold of a winner and are sitting on big profits, you may unsure what to do next…
Do you take those gains off the table? Or do you hold on in anticipation of even bigger potential profits ahead?
The dilemma can lead to plenty of frustration – especially if you make the wrong call.
But the options strategy I’ll explain today can help you avoid some pain…
Achieve Both Goals
If you’re bullish on a stock, the most obvious strategy is to buy the shares.
But you could buy a call option instead. A call option increases in value when the underlying stock rallies.
So a call option allows you to benefit from an upward move for just a fraction of the cost of buying the shares.
The downside is that time is constantly working against you…
If the move you’d hoped for doesn’t pan out within your timeframe, you run the risk of your option expiring worthless.
But buying a call option can have a secondary benefit…
That is, it can help you bank your profits… and give you exposure to further upside.
It’s called a roll…
So let’s see how it works. And then we’ll compare it to buying shares outright instead…
Catch Further Upside
Let’s look at AI chip juggernaut Nvidia (NVDA)…
(Please note that this is just an example and is not a recommendation.)
You may have decided to buy a call option on NVDA in January. NVDA kept rallying through to March, putting their position in good profit.
That’s where this simple roll strategy fits into the picture…
Rather than risking giving up those gains, you lock in those profits by selling your call option.
You then use a portion of those winnings to buy another call option with a later expiration. That lets you avoid missing out on any further upside (roll No. 1).
So let’s continue with the example…
After a pullback into April, NVDA rallies again – right up to its all-time high in June.
But with NVDA retracing again, you become increasingly worried about giving back profits.
So you roll your option again (roll No. 2)…
Nvidia (NVDA)
Source: eSignal
You sell your call option, locking in your second lot of profits. You then buy yet another call option with a later expiration to capture more upside.
This time, though, NVDA retraces and keeps falling, causing the call option to drop in value.
Remember, though, you’ve locked in two lots of profit…
And because options only cost a fraction of buying shares, you’re risking far less by buying that call option.
And you can close out the trade by selling the call option prior to expiration to recoup some of that amount.
What’s more, your risk from this trade is already known. It’s the amount you paid for the call option premium.
In the end, you’re able to limit your risk, take profits along the way, and still have exposure to more upside using this roll strategy.
Compare that to buying shares instead…
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The Downsides of Shares
If you bought shares of NVDA, you’d take part in the rally all the way from January to June.
But you make no profit until you sell the shares.
You’ve also tied up a lot more capital than buying options.
Plus, if NVDA keeps falling, you run the risk of losing all of the money you could’ve made.
Now, to be fair, sometimes the rolled strategy doesn’t come off.
But the benefits of the strategy are clear…
It lets you keep banking profits when you’re worried about a potential pullback.
And it also gives you the chance to participate in any further rally… while also locking in your maximum loss.
Happy Trading,
Larry Benedict
Editor, Trading With Larry Benedict