Many of the Delta Hedging (DH) strategies that I frequently use revolves around selling further out of the money (OTM) options than I own to reduce or even eliminate the initial risk of a trade. That results in some version of a spread. If I don’t want to cap the potential profits of an instrument in the event it continues to trend in the expected direction I’ll use a rolling method whereby I sell the original option and purchase a further OTM option. It’s a simple but effective strategy of lowering the risk in a trade while allowing for potentially much larger profits.
2 examples below. They’re taken from the ThinkBack feature in ThinkorSwim. If a strategy provides an unsatisfactory result under the best circumstances I can eliminate that strategy from my trading toolbox. Simulating a long XLF Call purchase when price is starting to rally. As price moved higher I could have sold the original Call and used the credit received from that to purchase a further OTM Call and eliminate all of the initial cost of the original Call that I purchased. If XLF continued to move higher then my profits will grow but, should price reverse and move lower, the worst that I can do is have a breakeven trade.
If I have decided that the price action indicates the continuation of a strong rally, I might choose to leave some of the initial risk intact and leverage potential upside profits by selling the original Call to help finance 2 further OTM Calls. See that example below.
I think that is enough of an explanation to allow any trader who hasn’t considered this type of strategy to use their imagination of where this might prove most useful. For instance, consider longer-term options or even LEAPS on a stock that has tremendous upside trending potential but is also high risk.
As always, nothing in this post should be considered trading advice. This is simply an educational exercise to help traders discover new possibilities in trading!
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