We’ve been discussing “rolling” on this blog lately. It’s a common way options traders adjust options positions when their opinion on the underlying has changed, and they just want to buy a little more time to prove out their opinions. We’ve already covered examples from both the put and call sides. This week we’ll wrap up this series with a few final caveats and tips to help you roll with more consistent success.
“Rolling”: a quickie definition
“Rolling” is a way to try to put off assignment, or avoid it altogether. By closing out one front-month position and exchanging it for another back-month position with an adjusted strike, you can dodge assignment and potentially profit when the markets move against you. While rolling can be useful, it has its dangers, too: if you’re wrong, you can wind up compounding your losses over time.
My first post in this series explains how to roll a covered call sale and lays out the essential elements of “rolling”. Check that out first before reading on here.
Roll with success!
If you’re considering rolling, here are a few tips to keep in mind:
• Consider your current opinion. You’re probably thinking about rolling because your initial position is moving against you. Is it time to change your original opinion, or are you sticking to your guns? For example, if you sold a covered call hoping your stock would hit the strike and then get called away from you, you might consider rolling if the stock goes up and keeps rising.
• Roll out the shortest time period possible. A lot can happen in a few days in the options market, so try to limit the amount of extra time you tack onto your trade. You might even decide to accept a small net debit for your roll versus a credit that ropes you into a longer timeframe.
• If you’re going to roll, roll fast. The decision to roll or not to roll has everything to do with your forecast for the underlying stock from this point forward. If, for example, you’ve sold an option and it’s going in-the-money (ITM), if it gets really deep ITM the cost to buy back the short option will be steep.
When rolling, your goal is to sell another option and generate enough - if not more than enough - cash from the new sale to pay for the buyback of your short option. If the buy back is costly, it’ll force you to go further out in time to get the increased time premium to help cover your buyback costs. Bottom line then: decide whether you’re ready to roll (or not) when the position is no more than 2% to 4% ITM. Example: if you’re short a 50-strike call, you’d want to roll before the stock goes beyond 52 (50 x 4% = 2 points). Of course, every option behaves differently once it starts moving, so consider this a general rule-of-thumb.
If you don’t act fast, you may end up accepting a less-than-great net debit – and have very little chance of scoring a net credit on the roll.
• Consider “pre-emptive rolls”. You don’t have to wait until your trade is in trouble to act. If you see prices moving against you, you can always roll pre-emptively to protect yourself. It may help you lower the cost of buying back the front-month option and may secure you a net credit for the roll.
Of course, roll too early and you can simply be overreacting – you’ll have to finesse that part.
Rolling is not for the faint-of-heart, and it can take time and experience to do it correctly. Feel free to hit me with your questions or real-life rolling examples, good or bad. And here’s hoping you bowlers “roll” a strike everytime!
Regards,
Brian (OG)
[image: bowling pin ceiling by magnetbox 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.
