Adjusting 101: How to Roll an Options Position
In our first Adjusting 101 discussion, we talked about adding legs to an existing options position. Unlike stock trading, options traders have an arsenal of maneuvers they can perform mid-trade. In stock trading, we can buy, sell or do nothing. Aside from adding or subtracting an options leg though, another option is to roll the trade.
So how do we “roll a trade” exactly? Simply put, when we roll a trade, we’re closing an existing trade and simultaneously opening a new one on the same security. We can do this with either a winning or a losing position. Because options have a finite lifespan, rolling is a way for options traders to extend the timeline of their trade, so to say. Why would we want to do that?
In both cases — a winning or a losing trade — the prospects of the trade may still stand as an attractive endeavor.
For instance, say we’re bullish on ABC and the stock continues to trend higher. For an our example, say the stock was trading at $50 so we purchased the $50-$55 bull call spread for $1.75 expiring in 30 days. Well, 3 days before expiration and ABC is trading at $54. The spread is now worth $4.00, giving us a profit of $2.25. However, we believe that ABC will continue to move higher, so we decide to roll the position.
This is where it gets tricky. Not only do we have the option to roll the trade, but we have options on how to roll it. When one rolls, they do not have to sell their position — the $50-$55 bull call spread in this case — and purchase the same spread with a different expiration. However, if we were to stick with the same spread and were only looking extend the expiration date, it’s called “rolling out.” In this case, we’re simply extending the length of the trade by selling our spread and buying the same spread with a later expiration date.
If we want to move up in strike price to accommodate the higher stock price but keep the same expiration month, we would “roll up.” For example, perhaps we would be interested in the $52.50-$57.50 bull call spread or maybe the $55-$60 bull call spread. At this point in our example, with just a few days to go before expiration, rolling up may not make a whole lot of sense unless we believe there’s a lot of upside in a very short period of time.
However, it may make more sense in a “roll up and out” scenario. As you may have guessed, rolling up and out is a combination of buying a higher strike spread and moving out in expiration. For example, with our current $50-$55 call spread expiring in 3 days, perhaps we sell that spread and purchase the $55-$60 call spread expiring in 30 days.
There is one other term that we didn’t mention, which is “rolling down.” It is the opposite method of rolling up. When a trader rolls down, they are lowering the strike price involved. Say they are short upside calls and the stock price drops. They could “roll down” by closing out the higher priced strike and look to capture even more premium by selling a lower priced strike.
How to Roll a Trade on Defense
In the first example, we correctly played the move on ABC. If we were to believe the trend would continue in our favor, rolling up and out would make sense. However, that’s an example of how to roll an options position when we’re operating from a winning position. What about when we’re losing?
Say shares of XYZ are deeply oversold. The valuation is wildly low and the technicals are screaming for a bounce. It’s a good company but a bad stock at the moment. Knowing that we’d be comfortable owning the underlying equity at the given strike price, we opt to sell a few cash secured puts on XYZ.
In this example, say XYZ is trading for $66 and we decide to sell the $65 put for $0.90. Expiration is in 32 days. However, after 30 days go by, XYZ has not bounced the way we thought it would. Shares are now trading for $64. Our short put has a premium of $1.20, as the $65 put is $1.00 in the money. In other words, we are down $0.30 from our cost basis of $0.90.
The fundamentals are still good and the technicals remain oversold. In other words, our thesis has not changed and we are still comfortable owning the underlying security. However, we would prefer not to if possible, as our preference is to collect the premium from the short put sale. What options do we have left?
We could sell the position for a loss or hold out until expiration hoping for a bounce. However, we could also roll the position. In this case, we might consider just a “roll out.” We would keep the same strike price — $65 — and just extend the expiration. Say we bought back our short put and sold the next month out for $1.75. Keep in mind we’re buying our position back with a $0.30 loss, so we have to build that into the premium we collect in this case.
So rather than collecting $1.75 in premium, we are only hauling in $1.45, (not including commissions). However, should XYZ post even a meager bounce by the next expiration, our position could easily be in the green. Say it expires worthless, requiring only a move back to $65. This would allow us to keep all of the premium and letting us wash our hands of the previous trade.
Sometimes options trading works out exactly as we drew it up. Other times, we have to roll with the punches.