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Options Trading: Why Roll Up To Higher Strikes? MCP, REE

|Includes: iQIYI, Inc (IQ), REE

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Last Tuesday, rare earth metal stocks jumped, and they jumped fast.  They were moving so fast that we kept the plays in the Trading Room on that day.  But, in the article on Tuesday night, I said, "[Tuesday's] jump is a breakout from the range-trading in the past 2 months.  We could see both of these test their recent highs (REE $18; MCP $60+)."  

In last Tuesday's article, I also said, "Both REE and MCP look a little short-term overbought."  On Wednesday, these stocks pullback and we jumped in and bought Apr 50 calls on MCP at $4:

  • March 23, 2011
  • 11:57 | HappyTrading MCP ($50.00) Bought to Open 04C50 Apr 50 calls, at $4.00

The very next day, MCP popped and almost hit $57, from Wednesday's close of $51.62.  We locked in our gains as high as +83% and rolled to Apr 55 calls:

  • March 24, 2011
  • 07:50 | HappyTrading MCP ($56.30) Bought to Open 04C55 Apr 55 calls, at $4.00
  • 07:49 | HappyTrading MCP ($56.40) Sold to Close 04C50 Apr 50 calls, at $7.30 +83%
  • 07:28 | HappyTrading MCP ($55.20) Sold to Close 04C50 Apr 50 calls, at $6.30 +58%

Well, let's first visit the chart to illustrate what was happening:

MCP

When MCP first jumped last Tuesday, it closed above the old trading range on high volume.  This gave us good clues that MCP was heading even higher, especially with the news from China that rare earth metals prices have soared.  We waited until the quick pullback to take our position.  We had almost a double the next day.  With that much profit and 2 quick jumps in 3 days, we had to protect that profit.  By rolling up to higher strikes, we greatly reduced our risk, basically playing on the house money.

We exited the 50 calls at $7.3 and got into the 55 calls at $4.  In effect, we pocketed $3.3, and, instead of risking $7.3, we were only risking $4.  Since the range was broken and MCP went above the next resistance at $55, we were pretty convinced that MCP was heading into the $60.

Today, as MCP received a price target boost from $66 to $74 by JP Morgan, these stocks jumped again.  We took in more profits again on the rolled up Apr 55 calls:

  • March 29, 2011
  • 07:12 | HappyTrading MCP ($59.20) Sold to Close 04C55 Apr 55 calls, at $6.00 +50%
  • 06:56 | HappyTrading MCP ($58.50) Sold to Close 04C55 Apr 55 calls, at $5.60 +40%

While we sold the Apr 50 calls at $7.3, we gain another $2 from the 55 calls.  So, why do we roll up to higher strikes?  Why not just stay with the original 50 calls and cash in today?   

Because these stocks are volatile, the option prices can move very fast.  Yesterday, the Apr 50 calls traded down near $5, almost $2 lower than our exit.  If we had hung on to the 50 calls when MCP came down yesterday, we might have been shaken out of the trade and missed today's new jump.  But, since we already pocketed profits and our risk was low with the 55 calls, we felt more comfortable to stay with the trade.  Further, on a precentage basis, we win with rolling to higher strikes, as the 55 calls were up +88% today, as opposed to the 50 calls with only a +61% gain.

So, to summarize, in a fast moving stock, the advantages of rolling up to a higher strike are:
1)  pocket some gains and risk less
2)  less likely to get shaken out before the final target is reached
3)  bigger % gain with higher strikes

One last advantage is that as the price of the stock keep getting higher, the deeper, within-the-money strikes will become less liquid as they loose the premiums.  For example, the 50 calls only traded 600 contracts today, while the 55 calls traded 2,622 contracts.  Further, when the options move beyond $10, you'll likely see the spread widen as well, which contributes to the lack of liquidity and makes them harder to trade.

So, if you're sitting on lots of profits on an options trade, and you're confident that the stock is moving higher, consider taking some profits and roll up to the next strike, and/or next month!

Good night and HappyTrading! ™ (click to see our Facebook Page)



Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.