What hedging strategy can I use to approximate selling one half of an in-the-money option contract?

Question

Apologies if the question title is confusing; I'll explain:

I have one contract of an expensive call option which is in-the-money and expires next year. It has roughly tripled since I bought it, and normally I would sell about half of it to lock in some of the gains. Since I can't sell 50 options, my only choices are to sell all of them, or hold all of them.

I imagine there is a strategy involving either buying puts or selling my calls and buying different (cheaper) calls (or both) which would have approximately the same return as selling 50 of my options (if that were possible).

What is the best approach?

Answer 1

Thanks - I have 1 contract (100 options). The 50 options that I would sell (if it were possible) means 1/2 a contract and that's what I'd like to "simulate" (returns-wise). –

Just to get on the same page and lingo, in the US, one standard option contract represents 100 shares not 100 contracts.

There are a number of things that you could do and they vary in complexity and outcome. The choice of which depends on the trade offs that you're willing to make. I'm going to keep it simple and just mention two.

The first choice is to buy an ATM put. This creates a Guts Strangle. Its advantage is that it locks in your current gain and allows you to participate to the upside. Between the strikes you'll break even and below the call's strike you'll start profiting again, should the stock collapse. You could buy an OTM put that costs less. That would lock in less, give back more if the stock dropped but give you more upside.

Example with made up numbers with calculations on an expiration basis

XYZ is $50 and you initially bought a 1 year $50 call for $5. XYZ rises to $65 in a short time and the call is now worth $16. Buy the same expiration $65 put for $6. You'd be throwing away $6 of your $11 gain. Between $50 and $65 you'd make $4. Below $50 you'd make a dollar for every $ XYZ stock dropped as you would above $65 for every $ that XYZ rose.

Plan B would be to roll the call up. At $65, the $50 call worth $16 would have a delta of about 90. The $65 call would trade at about $6 and would have a delta of about 50+ or almost 1/2 your initial delta of 90, achieving your goal of approximately 1/2 a position, so to speak. Delta is non linear so the $65 call won't track at exactly 50% but it's close enough. You'd book an $11 profit with a guaranteed $5 gain and be in approximately the same situation as when you started with the $50 ATM call.

The first suggestion has a better upside because of the much higher delta. Prior to expiration, the options would have salvage value but I'm going to leave that alone since it gets deeper into the weeds.

Answer 2

Here are the facts you’ve noted: paid $x to buy call options, can sell for about $3x.

Here’s a simple strategy: consider selling your calls and just buying out-of-the-money calls with the original principal. You’d have double your principal in hand no matter what, and you’d participate in more if the price goes high enough.

Answer 3

The best answer depends on a number of factors including commissions, assignment fees, stock borrow costs, account limitations, and the risk you are trying to hedge.

Buying puts would increase your gamma (and therefore time decay), but would reduce your exposure to the stock.

Shorting 50 shares of the underlying stock would decrease your exposure to the stock, but you may have to pay expensive stock lending fees. It would not change your gamma.

Selling this call option to buy one with a higher strike would reduce your exposure to the stock. However, it may increase your gamma and time decay (at-the-money-forward options typically have the highest gamma).