The surge in tech stocks last year left many investors with the kind of problem you want to have.
With their accounts sitting on big profits, they had a choice…
Do they take their gains off the table… or hold on in anticipation of even bigger potential profits ahead?
It’s the kind of dilemma that can lead to plenty of frustration if you make the wrong call.
If you hold on too long, the stock might tank. Or if you decide to sell too early, the stock could go onto make new highs.
Missed profits can be as frustrating as losing money.
But if you apply this simple strategy, you can get the best of both worlds…
Achieve Both Goals
If you’re bullish on a stock, then the most obvious strategy is to simply buy the shares.
But in many cases, you also have the choice to buy a call option instead.
A call option allows you to gain exposure to a stock 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 in your timeframe, then your option could expire worthless.
Yet one benefit of buying a call option that some traders miss is that it enables you to achieve two goals.
You can take your profits off the table… and gain exposure to further upside.
It’s called a roll.
When the move you planned for comes off, then you close out your bought call option to lock in your profits.
At the same time, you open up a new call option to help capture further upside.
So let’s see how it works…
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Capturing Upside
Consider the chart of JPMorgan Chase (JPM) below. (Please note that this is just an example and not a trade recommendation.)
You can see the Relative Strength Index (RSI) forming a ‘V’ (red circle) and rallying out of oversold territory (lower grey dashed line). So a trader may decide to open a long position by buying a call option.
If JPM rises, that will increase the value of the bought call option.
JPMorgan Chase (JPM)
Source: e-Signal
But as we come into 2024, JPM looks to be running out of momentum…
The stock price is failing to make new highs and sliding instead. It’s actually about to test its 21-day moving average (MA, red line).
Plus, the RSI is steadily falling (orange line). If the RSI continues to fall, JPM’s slide could accelerate.
That’s the dilemma I referred to earlier where you can get caught in between two possibilities.
If the trader closes out their position (by selling their call option), they could miss out if JPM finds a base and starts to rally again.
But if they continue to hold their position and JPM’s fall accelerates, they could give back a big chunk of their profits.
That’s where this simple “roll” strategy fits into the picture.
By selling their call option, they lock in their existing profits. Then by buying a new call option (typically with a later date and higher strike price), they gain exposure to any further upside.
If scenario 1 plays out and JPM does keep rising, then they’re set to profit from the next leg of its rally.
And if the second scenario occurs, they’ve already locked in their profits from the first leg.
And the amount they’ve risked and could potentially lose on the second leg is already fully known. That’s the amount they’ve paid for the call option premium.
Like any strategy in the market, rolling a bought call option doesn’t always work out as hoped.
Sometimes the stock just drifts, eroding the value of the option over time.
However, the benefits of the strategy are clear…
It enables you to bank your profits. And it gives you the chance to take part in any further upside for a predetermined cost.
Regards,
Larry Benedict
Editor, Trading With Larry Benedict
Mailbag
Have you ever used the “roll” strategy? How did it turn out for you? Let me know at [email protected].