Last week we kicked off a new mini-series on rolling, a common way options traders adjust options positions when their opinion on the underlying is unchanged, but they just want to buy a little more time to prove out their opinions. Last week’s post explained how to roll a covered call sale – and the many pluses and minuses that move entails. This week we’ll run through an example on the puts side, explaining how you might decide to roll a cash-secured put. A cash-secured put means we have the means to buy the stock if need be. Example: we sold the 50 strike put, knowing this sale is an obligation to buy the stock at 50. If that obligation comes to fruition, that means we need $5,000 to purchase the stock, so we make sure the 5k is in the account before we enter the trade. This type of trade can be done in an IRA account at TradeKing with the proper option trading approval level.
Again, you can roll either a long or a short position, but for the sake of simplicity we’ll be dealing only with the short side in these examples.
Our second example: rolling a cash-secured put
Let’s imagine you’ve sold a cash-secured put according to the following terms:
Stock ABC at 51
Sold 1 30-day 50 Put at 0.90
ABC moves against you to 48.50
When we put on this trade, the goal was for the stock to dip just below 50 and stay there until expiration, at which point the put would probably be assigned, and we could buy the stock at a lower price. So our outlook to start was short-term bearish but long-term bullish. But now our view has changed: we see more downside in the chart than we’d like, so the new plan is to delay being assigned or avoid it all together. The put is now in-the-money (ITM) and we’ll most likely be assigned at expiration if no further action is taken. (To learn more about exercise and assignment, check out my blog series on the subject, which begins here.) If only you could buy yourself a little more time to see if your forecast for the underlying is correct.
Just like last week’s covered-call example, you have issues. If you wait until expiration the put may be exercised and you would be forced to buy ABC at 50 – something you may no longer wish to do. Your first option is the obvious one - buy back that 50 put you sold at a loss, canceling your obligation. The next one to look at is to “roll down and out”, buying the 50 strike back to close and at the same time selling a lower strike put option (“down”) that’s further “out” in time.
If you decide to roll, you’d head over to TradeKing’s spread order screen and enter the roll as one trade, which assures both legs of the trade will execute at same time:
Buy to close the front-month 50 put -1.55
Sell to open a 47.50 put that’s 60 days from expiration +1.70
= 0.15 net credit for the roll
Good news and bad news
Rolling helped you score a 0.15 net credit and a little more time. Add that 0.15 to your initial premium received for selling the cash-secured put (0.90), and you could walk away from the trade at expiration with $1.05 if the 47.50 put expires worthless.
Of course, things may not end up that way. If you’re wrong and the stock continues to drop, you will have taken a loss on the front-month put and will also have a loss on the new option. After all, anything can happen in the next 60-day period. Rolling can help buy you time, but it could also compound your losses.
Next week we’ll wrap up this “mini-series” on rolling with a few final tips and caveats to help you roll with confidence and discretion.
Regards,
Brian (OG)
[image: squircled wheels by Claudecf on flickr]
Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options.
While implied volatility represents the consensus of the marketplace as to the future level of stock price volatility or probability of reaching a specific price point there is no guarantee that this forecast will be correct.
Any strategies discussed or securities mentioned, are strictly for illustrative and educational purposes only and are not to be construed as an endorsement, recommendation, or solicitation to buy or sell securities.
