Got a question about options? Jay Kaeppel has over three decades of expert- cence in the options markets. He was a head trader for a CTA firm, an options trading software developer, and is a portfolio manager for an investment ‘management frm. He also spent several years writing a weekly column tiled “Kaeppel’s Comer” and now publishes a blog, “Fay On The Markets” (itp: Jayonthemarkets.com). He i the author of several books, including The Four Biggest Mistakes In Option Trading; The Option Trader's Guide To Probability, Volatility, And Timing; and Seasonal Stock Market Trends. Send your ques tions or topic suggestions to Jay Kaeppel at jaykaeppel@gmail.com. Selected {questions will appear ina future issue of S&C. MAKING ADJUSTMENTS TO ‘AN OPTION POSITION of adjustments the trader can make to the existing position to improve on the Thave a decent open profit on a long cell position. I think the upward price trend will ultimately continue but I'm concerned that there will be a pullback in the meantime and that a lot of my profit will evaporate.Tknow Icould sell ‘my calls and try to buy them back later, but Fmnot sure Till pull the trigger 10 ‘get back in if] get out now. Is there an original trade. Phase 1: The original long call position The original example position involves buying eight SLV April 2019 14 strike price calls with SLY trading at $13.62 a share. The cost (and maximum risk) at outset was $464, There were 136 days ‘alternative? Yes, there ate lots of a> ternatives. AsTwrote about is an | [Gown youself last month in this column, ome Hrwsunen met! | ay gace guns a ‘options offer investors and traders unique opportuni- toimprove the reward/ risk ratio for a given trade via an “adjustment” to an ‘option position. To illus- trate this, le’s consider an ‘example like what you've described. Let’s say that Sell OTM calle against profitable fang calls ny Kaeppel Jeft until April expiration and the trade had unlimited profit potential Thirty days later, SLV had rallied from $13.63 to $1475 a share and the Jong call position had an open profit of +5456. The good news is thatthe trade was doing very well. The bad news is that there was still a risk of giving back the profit and losing the original $464 spent to enter the trade, we've taken a long posi- tion in calls on ticker SLV and that: 1. Wenowhaveasignifi- cant profit 2. We expect/hope the upward trend in price will ultimately con- tinue But SLV feels like it’s “overbought” and vwe'reconcerned about pullback in the near term. AA yee What can the trader do? Let’s explore a progression FIGURE 2: RISK CURVES FOR ADJUSTED POSITION OW 1/3/2018, 2b» ape 2019» Tonia Antivof STOCKS & COMMODITIES ot)Phase 2: Sell out-of-the- money (OTM) calle SS ‘At this point, a trader | EXE vcore sae ie ae might consider adjust- ing the original position to improve the tradeoff between reward and risk, withoutcompletelyexiting Paans.s seam the orginal position. aayarsy st Lets assume the trader Po = believesSLV isoverbousht = and due for some sort of price consolidation, but the trader doesn’t want to FIGURE 3: TRADE PARTICULARS AFTER SECOND ADJUSTMENT ON 1/22/2019 exithetradecompletely.In [=o thiscase,onesimple choice cae i wouldbetoselleigh OTM |, HECABES/A0ehewiny( YA April 15 strike price calls, as shown in Figure 1. This action has several effects that can be seen in Figures and 2, inch + For now, maximum Profit potentials once agsin unlimited . THT TOT profit potential is Kim- ited t0 +8816 + Masimiuns risk is now a locked-in profit of | +818 7 1 tts nye Worst case ia profit of + + The delta on the trade barked, oa is now 184, which Sen ode ode wet bee ae = ? oe means this position sew Sai is roughly equivalent | TOURE 4: RIK CURVES FOR POSTION AFTER 13/2019 ADWUSTMENT to holding 184 shares of SLY. a result, the price of the April 15 calls in enjoys un- Phase 3: Wait for the expected pullback Now we have to wait patiently to see Where SLV goes next. Twenty days later, SLV shares had drifted lower from $1475 to $14.42 a share, and impli ‘volatility forthe April 15 calls dropped from roughly 21% to roughly 176. As Selling OTM calls against a profitable long call position can offer the trader a way to reduce risk and to better ride out a short- term pullback. that we sold short hi fallen from $0.60 t0 $0.28, Phase 4: Buy back the short calls At this point, we can make one more adjustmenttoimprove ourreward-to-risk scenario by buying back the short 15 strike price calls and selling short four of the original long calls as follows: ‘+ Sell four ofthe eight April 14 calls that we bought originally ‘+ Buy back the eight April 15 calls that we sold 2¢ days ago. ‘As shown in Figure 3, selling the 15 callsand thenbuying them backatalower price and selling half of our original Tong call position accomplishes several things, including: limited profit potential * The worstease minimum profit is now +884 * The position delta jumps to roughly 273, Figure 3displaysthe particulars forthe trade after our second adjustment, and Figure 4 displays the new risk curves. Selling OTM calls against a profitable Jong call position can offer the trader a ‘way to reduce risk and to better ride out short-term pullback. If the pullback occurs, the trader may then be able to buy back the short calls at a lower price, The profit on that trade improves the overall reward-to-risk profile of the original trade, qC”—nEmmEEa) ‘Ap 2019+ Teche Anabof STOCKS & COMMODITIES + 25