Call-Spreads: Why They’re critical in the $5k to $1M Challenge and why they’re absolutely necessary in hedging risk

Lately, I’ve read a lot of comments on the issue of selling call-options against a long call-option we own. We’re covering the issue in-depth in Chapter 4 of Investing Basics, but I’d like to highlight a few issues here in a blog-post.

First, let me say this. As the Targaryen and Lannister Portfolios are concerned, they’re far more advanced portfolios with a much higher risk profile than a regular common stock portfolio. Absolutely essential to the risk management aspect of these portfolios is the ability to create call-spreads at any moment. It is a necessary aspect to effectively managing the trades.

In fact, our entire strategy in the Targaryen Portfolio ($5k to $1 million challenge) involves producing leveraged returns through the purchase of Call-Spreads. During the next market correction, we will eventually buy a vertical call-spread outright.

Allow me to illustrate just how important the ability to purchase vertical call-spreads really is. And it is absolutely essential.

Consider the Lannister Portfolio. We bought the Nvidia December 2026 $90 Call-Options at $43.80 x 4 contracts. They’re currently trading at $78 or somewhere around there. They’re up huge from when we bought them.

Now consider how we can reduce our risk in that position. Remember, we paid out $43.80 x 4 contracts ($43.80 x 400 = $17,520). One might argue if that we could employ a strategy that would essentially return our original $17,520 cost back to our portfolio (while still owning the position), that we’d now have literally ZERO RISK. We’d have a $0.00 cost-basis position under those circumstances right? Our original capital investment was $17,520 and we managed to both continue to own 4 contracts while also receiving back $17,520 in our account.

Well that is precisely what being able to sell call-options against a long leap option allows us to do. In fact, that is what we started doing this week. A few days ago we sold the January 17, 2025 Nvidia $170 calls for $4.25 per contract x 4 contracts giving us back $1,700.00. We reduced the cost of our Nviida December 2026 $90 call options that expire in two years from $43.80 per contract to $39.55. And if come January, Nvidia is NOT trading north of $170 at expiration, that is a permanent reduction. We got back $1,700.00 and have reduced our risk down from $17,520 to $15,820. If Nvidia somehow went to $0.00, that’s the most we can lose now because of the calls we sold against our position this week.

Worst case scenario, Nvidia rallies past $170 and we’re forced to sell our leaps at $90-$95 — oh no. We’d make 110% and can buy back later.

The point here is this. Being able to sell calls against my long Nviida leap is absolutely essential to risk management. Obviously, buying puts helps considerably as well and that’s what we’ve already done. We bought the Nvidia December 2025 $100 puts at $10.00 per contract. If Nvidia crashes to $100 several months ahead of December 2025, that position will skyrocket to like $30+ and hedge our Dec 2026 calls. We outlined the hedge and its merits earlier in a different post. It’s a good hedge.

But I’d like to stay focused on this issue of vertical call-spreads and why they’re essential to risk management. Let’s apply this issue to the recent Targaryen trade we made ($5k to $1M challenge) and illustrate why selling calls is absolutely necessary as a risk management strategy.

Initially, we bought 2 contracts in the January 17, 2025 $500 QQQ Calls at $15.00 per contract or thereabouts. The QQQ rebounded and we sold 1 contract at $18.45 producing a $345 profit which is about 7% of the portfolio. We also had $345 in unrealized gains for a total gain of like 15%. This by itself would have been a good return for such a small trade.

Having 1 contract remaining, we decided to use the profits from the sale of the 1 contract to buy the $500 puts expiring this Friday at $2.60. The idea behind that is if this is just a small bounce in a larger correction, then we should see immediate heavy selling ensue after the QQQ hangs at around the midline-RSI for a few hours. We didn’t quite get that outcome.

Here we are on Thursday with the QQQ now trading at $505 and with the puts having dropped to $0.70 and with the other long position having risen slightly to $19.50 with highs well north of $20.00.

So question is what are our risk management option going forward?

(1) We could buy another put expiring next Friday. For example, we could sell tomorrow’s put at $0.70 right now and buy Next Friday’s put at $2.80. That would increase the cost of our protection from $2.60 initially to $4.70 total. That’s viable given that we’ve already booked a $345 profit and have another $400-$500 in unrealized profits in the 1 contract we’re still holding in the January 2025 $500 QQQ calls. That’s one idea. And doing so would mean that our cost basis in the 1 contract we currently hold rises to $15 + $4.70 = $19.70. That’s the price level we’d have to sell our call position at to break even if the QQQ closes north of $500 next Friday.

Now let’s compare that to being able to sell calls against our long call position (creating a diagonal spread).

(2) As we just recently did, we could sell the Nov 29 $512 calls at $2.15 as a hedge — they got as high as $2.40 recently. By selling those calls at $2.15, we REDUCE our cost-basis in the call we’re holding. instead of those calls costing us $15.00, they now cost us only $12.85. On top of that, we have a profit of $345 minus the $260 we paid in this week’s hedge giving us another $0.85 discount or $12.00 total cost with this week’s and next week’s hedge.

That means we could see the QQQ roll over and our position can fall to $12.00 and we’d be even on the entire trade. For that to happen, the QQQ would have to sell-off all the way back down to $494 or lower. Hence, why selling those “covered” calls would inherently hedge us. We’re protected all the way back down to $494 and only have like $1200 at risk now.

What’s more, if the QQQ were to sell off tomorrow, those puts could easily go back up to $2.00 allowing us to further reduce our cost down to $10.00 or $1,000 at risk.

To profit, we just need the QQQ to stay where it is or go up a few points. If we ultimately sell the puts at $2.00 and the current call position we own at $20.00 AND if next Friday the QQQ doesn’t go past $512, we end up with $1,000 gain. If the QQQ does go past $512, we end up with an even larger gain of probably $1500+.

But that’s based off of selling calls instead of buying more puts to hedge. The put to hedge was good for an initial risk reduction strategy. Really good because in most cases, if we’re in a correction, the QQQ is going to roll over almost immediately. But here, that didn’t happen. So to maintain our long position, we have to take less drastic hedging actions and that involves selling “covered” calls (calls against our position) rather than adding more capital to the trade by purchasing more puts — if that makes sense.

So that covers the hedging aspects of being able to create spreads by selling calls against our long call position. But outside of hedging, buying vertical call-options is the entire strategy.

Allow me to explain why Call-Spreads are absolutely necessary to the core strategy. Let’s take a look at Nvidia (NVDA) right now at this exact moment. The stock is trading at $147.22. Let’s consider the January Nvidia $150-$160 call-spread expiring on January 17, 2025 — that’s 57 days from now. Right now, to buy the Nvidia $150-$160 call-spread, it only costs me $3.75. If I bought $5,000 worth of that spread at $3.75, I’d get 13 contacts costing me $4,875. Okay. Now let’s consier what happens if Nviida closes north of $160.00 come January 17. Hell, let’s assume it closes at $160.01 on January 17, 2025.

If that happens, that call-spread will go up to $10.00 (maximum) and be worth $13,000 exactly. My portfolio would be valued at $13,125. We’d nearly TRIPLE our money and all that would be required is for Nviida to rally a mere $13.00 in the next 57 days. That’s only 8.8%.

Now let’s apply this scenario to a correction. Let’s suppose we’re back in September and Nvidia is sitting there trading at $103. We could have bought the Nviida $105-$115 call-spread expiring in 57-days and all Nvidia would need to do is simply rally back past $115 and close past that at expiration and we’d get the same exact result. $5,000 to $13,000 (160% returns).

Except the big difference is that after a correction has occurred, Nvidia has an extremely high likelihood of actually rallying past $115. And it did. By the equivalent expiration time-line, Nvidia was at $140. That’s a full $25 past the upper strike. We wouldn’t even need to wait for Nvidia to reach the expiration date. At that point, being $25 in the money, the spread would essentially be at full value. We could sell at like $9.00+. At $9.00 x 13 contracts = $11,700. We’d have accomplished our goal very easily.

Now obviously we could get these same results with regular call options. You don’t need verticals to accomplish the same exact return. The big difference is that with regular call-options, it requires more precision. With a spread, we only need Nvidia to simply move back above $115 after having fallen 25%. The drop increases the probability that Nvidia will skyrocket on a bounce AND it increase the probability that Nviida will trade FAR FAR north of the spread upper strike by the expiration date. It lowers our overall risk and drastically increases the probability that we’ll meet our target if that makes sense. There’s a very good chance this portfolio perform as expected because we’re making very high probability bets that will all be hedged out anyway.

Furthermore, in our scenario, we’d only need Nvidia to rally a mere 8% $105 to $115). With long calls, we’d need the actual big move up into the $130’s for the trade to be successful. It’s much much harder to accomplish our end goal with calls than with call-spreads. It can be done, but it’s more difficult with a lower margin of error.

As we noted in the actual strategy, which can be found in this article here, the goal is to successfully execute 8 of these trades over a 4-year period. 8 successful consecutive vertical call-spread trades amounts to $5k > $1.2 million.

Trade 1: $5,000 to $10,000
Trade 2: $10,000 to $20,000
Trade 3: $20,00 to $40,000
Trade 4: $40,000 to $80,000
Trade 5: $80,000 to $160,000
Trade 6: $160,000 to $320,000
Trade 7: $320,000 to $640,000
Trade 8: $640,000 to $1,280,000

This above its the goal. In between these larger “spread trades” we’ll make trades like the one we just executed this week. Even just adding 10% here or 20% there can make a massive difference in how quickly this trade progresses. For example, consider this. Imagine, we conclude this recent “smaller” Targaryen trade with a $1,200 profit. The portfolio is now at $6,200.00. We make another small trade and close that out at $800 profit. We’re now at $7,000. A major correction happens. Now instead of starting at $5,000, we’re starting at $7,000. You end up with this:

Trade 1: $7,000 to $14,000
Trade 2: $14,000 to $28,000
Trade 3: $28,000 to $56,000
Trade 4: $56,000 to $112,000
Trade 5: $112,000 to $224,000
Trade 6: $224,000 to $448,000
Trade 7: $448,000 to $996,000

Notice we’d arrive at the end of the challenge a full trade early. And that’s the result of the compounding interest rate effect being exaggerated on each trade. And we’ll make trades in-between the spread trades to help accelerate the process.

But the broader point I’d like to make here is this. The Targaryen strategy calls for using diagonal spreads, vertical spreads, covered calls etc. to get it done. Generally speaking, brokers require a margin account and higher tier trading approval to be able to trade spreads. I can say it’s something that is regularly done and many advanced individual investors probably have it activated. If for nothing else, the risk management strategies that can be deployed with vertical/diaganol call-spreads are enormous.