Last week, we talked about a covered call trade in Advanced Micro Devices (AMD - Free Report) in which we bought shares in AMD and simultaneously sold calls against the shares. The thesis was that we could take advantage of significant momentum in the stock and the relatively high implied volatility in the September out-of-the-money calls - which was then over 77%.
We bought shares at $28.50 and sold the calls which had 15 days left until expiration for $1.25 each.
The trade has worked out well as AMD has rallied right through the 30 strike and is currently trading $33.75/share. That puts our calls firmly in-the-money and if the shares stay above the $30 level through expiration next week, we will sell the shares, leaving us with a profit of $2.75.
That’s a 10% gain in just over two weeks – a terrific return.
Two weeks ago in Know Your Options, we talked abut rolling covered calls “up and out,” buying back calls we had previously sold and simultaneously selling calls with a higher strike and a longer-dated expiration to avoid selling the stock and continuing to participate in a rally.
Is that a good idea in our AMD trade?
The AMD trade worked so well so quickly that rolling up and out doesn’t make much sense. Our September 30 calls are more than $3 in-the-money, and are currently trading for around $4. To sell another call with a higher strike and longer dated expiration for around $4, we’d have to go to the November 35 calls which would add 56 days to our trade and only get us a potential profit of $5 more, or the January 37 calls which would add $7 more in profit opportunity, but add a whopping 119 days.
Given how quickly we made our 10% profit, neither of those seems like an advantageous trade.
There is one thing we might want to consider, though. Locking in the profit.
Right now, we can still lose on the trade if AMD were to reverse trend and fall back below $30/share before expiration next Friday. If it were to go below $27.25/share, we’d give up all the profits on the trade and below that, we’d actually start losing money.
The September 30 puts are trading around $0.40. If we buy one of those for every 100 shares we own, we can lock in a profit of $2.35 and forget about the trade as we will have no risk. That’s still an 8.5% profit in just one week – still a very a successful trade.
This is mostly a question of personal risk tolerance. There’s no right or wrong answer. In this situation, if a trader wants to “let it ride” and wait for expiration next Friday, hoping AMD shares stay above $30, giving us the maximum profit, that’s a perfectly rational decision - as a 10% reversal seems like a fairly remote possibility.
If the same trader wanted to lock in most of the profit, stop thinking about the trade and move on to the next opportunity, that’s perfectly rational as well.
There’s not always one correct answer.
Today's Stocks from Zacks' Hottest Strategies It's hard to believe, even for us at Zacks. But while the market gained +21.9% in 2017, our top stock-picking screens have returned +115.0%, +109.3%, +104.9%, +98.6%, and +67.1%. And this outperformance has not just been a recent phenomenon. Over the years it has been remarkably consistent. From 2000 - 2017, the composite yearly average gain for these strategies has beaten the market more than 19X over. Maybe even more remarkable is the fact that we're willing to share their latest stocks with you without cost or obligation. See Them Free>>