Time to Book Some Gains?

Time to Book Some Gains?

This Option Reduces Risk 

And Offers Upside Potential

For the first time in seemingly months, the market has a bit more negative tone. In the past week, we’ve seen persistent selling as the market’s retreated from all-time highs.

Fears of the direction of the Federal Reserve, turmoil in Egypt and the constant selling in the Emerging Markets are flashing warning signs for the markets.

So maybe its time to book some gains on some of your winners.

So how do you lock in gains on some of your stocks, while still maintaining potential for upside exposure?

One way to do this is an options strategy called Stock Replacement.

To execute a Stock Replacement strategy, you sell your stock holding and buy an In-the-Money Call option against it. When you do this, you lock in your gains in the stock while your call gives you upside exposure.

Let’s assume you own 100 shares of TSLA that you bought when Cabot Stock of the Month Editor Tim Lutts recommended it at 29. Today, TSLA is trading at 147 and you are sitting on a profit of $11,800 on your 100 shares.

You may be starting to get nervous about the market, or perhaps the TSLA story. So you execute a Stock Replacement strategy to reduce your risk.

First, you would sell your 100 shares of TSLA leaving you with no stock position. Second, to give you continued upside exposure, you would buy one TSLA September 140 Call (expiring 9/21/2013) for $12.00 for a capital outlay of $1,200.

You would have booked your profit of $11,800 (having sold the stock at 147) giving you $14,700 in your account, minus the $1,200 you paid for the one call, for an account total of $13,500.

Here is the profit and loss graph of your remaining position:

Tesla Call Option

As you can see in the graph above, the most you can possibly lose on this position is the premium paid for the call, or $1,200. On the other hand, before you sold your TSLA stock position, you had $14,700 at risk.

The graph also shows that you continue to have upside exposure almost equal to your former stock position.

In conclusion, Stock Replacement strategy allows you to lock in profits on your stock positions, reduce your risk and continue to give you the stock’s upside potential. 

To learn more about the Stock Replacement strategy and to find out additional ways on how using options can increase your wealth, click here now.

Your guide to successful options trading,

Jacob Mintz
Analyst and Editor, Cabot Options Trader

Editor’s Note: Jacob Mintz is a professional options trader and analyst of Cabot Options Trader. Using his proprietary options scans, Jacob creates and manages positions in equities based on risk/reward and volatility expectations to get subscribers the highest returns. Jacob’s most recent winners include: 40% profit in a SPY Put, 92% profit in a SU Call, 32% profit in a SD Call.

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