By Chris Ebert

It isn’t easy for a trader to take a vacation. To do so involves intentionally ignoring the market for an extended period of time, although ignoring the market while holding open positions is often stressful. Sure, a stop loss order can be used to minimize the risk of any huge drawdowns while a trader is on vacation. But stop losses can themselves generate stress because of their ineffectiveness against overnight price gaps and also their tendency to be triggered at unfavorable times due to whipsaw.

To avoid the stress associated with stop losses, some traders prefer closing all stock positions before taking a vacation. Obviously, moving to all cash will prevent any losses, but it also means giving up any potential gains. For a trader willing to add a small amount of risk, there are option strategies that are highly suitable for situations in which watching the market becomes a lower priority than watching the waves wash up on the shore.

Very Low Risk /Low Reward

Buy one deep in-the-money put option for every 100 shares of stock owned. The deeper the option is, the lower the risk of loss and also the lower the potential profit. Options that are deep in-the-money have very little time value, so the potential loss of time value is also very small, but the potential gain in time value can be significant as can be seen in this example:

A trader bought 100 shares of Apple (AAPL) at $550 and it is now trading at $600. Rather than take the $5,000 profit by selling the shares prior to taking a 2-week vacation, 1 put option is purchased at the $630 strike ($30 deep in-the-money) and expiration 4 weeks away, for a premium of $32 per share, or $3,200 total.

Scenario #1: Upon returning from vacation, the trader finds that AAPL has fallen to $570 and the $630 puts are no longer being traded because they are now $60 in-the-money. The broker is then instructed to exercise the option early, and the stock is sold for $630 per share. Net proceeds from the sale are $63,000 less the $3,200 paid for the option, or $59,800, which is only $200 less than the $60,000 that would have been received if the shares had been sold before the vacation began. The $5,000 potential gain was only reduced to $4,800.

Scenario #2: AAPL shares are trading at $630 at the end of two weeks and the $630 puts are now trading at $9 per share. The trader then has the choice of selling the put for $900 (a $2,300 loss) and holding onto the shares (which now have an $8,000 unrealized gain), or simply closing the entire trade for a $5,700 net gain. Of course the gain was reduced considerably by the loss on the put option. But, the ability to make additional profits without any attention to the market for two entire weeks can be attractive to some traders, especially when only $200 is at risk. The $5,000 potential gain was increased to $5,700 in this case, and could have gone much higher if AAPL had exceeded $630.

Moderate Risk/Moderate Reward

Sell one deep in-the-money call option for every 100 shares of stock owned. The option becomes a “covered call” because it is covered by shares that are already owned. Just as with the protective put option in the above example, the deeper the option, the lower the risk. However, the downside risk of the covered call is much higher than that of a protective put, as can be seen in this example:

A trader purchased 100 shares of Priceline (PCLN) at $650 and it is trading at $690 prior to a planned 2-week vacation. In lieu of selling the shares at a $4,000 profit, 1 call option is sold at the $660 strike ($30 in-the-money) and expiration 4 weeks away, for a premium of $36 per share, or $3,600 total.

Scenario #1: After vacation, PCLN shares are trading at $660, and the $660 call options are trading at $16. The trader has a choice; if the price has found support, the trade can be left open until expiration and 100 shares will be called away at $660. The result will be a $1,000 gain on the stock and a $3,600 gain on the option for a total profit of $4,600. The $4,000 potential profit was increased by 15%.

If the price has not found support, the trade does not necessarily need to be closed. Assuming PCLN retraces all the way back down to the $650 purchase price, the $3,600 profit on the call option will be retained when it expires worthless. That’s only $400 less than the gain that would have been realized by selling the shares at $690 before the vacation began. In this case the $4,000 profit was only reduced by 10%. However, there is always a risk that the price falls below $650 and wipes out all of the gains and eventually results in a loss.

Scenario #2: PCLN climbs to $700 and the $660 call options are trading at $45. Again the trader has choices. Ride out the trade until expiration; take the $1,000 gain on the stock and the $3,600 gain on the call option when it is assigned. The $4,600 total gain is 15% higher than what would have been realized prior to vacation. Or, buy back the call option at a $900 loss and hold onto the shares which now have a $5,000 unrealized gain. Or, sell the shares at a $5,000 profit and take the $900 loss buying back the call. In either of these cases, the $4,100 profit is still a 2.5% improvement over the pre-vacation sale.

The preceding is a post by Christopher Ebert, who uses his engineering background to mix and match options as a means of preserving portfolio wealth while outpacing inflation. He studies options daily, trades options almost exclusively, and enjoys sharing his experiences. He recently co-published the book “Show Me Your Options”.

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