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Editor’s note: This post was originally published on Wednesday, December 23, 2020.
“Rolling options” is a common transaction for options traders, but there are several ways to do it. This article will explain the different ways and reasons why traders might roll positions.
These are the key points we’ll cover:
Rolling options is the practice of moving from one call or put on a certain stock to a different call or put on the same stock. It involves exiting the current position and immediately entering a similar position. The underlying stock or exchange-traded fund (ETF) remains the same.
Say an investor owns the January 2021 120 calls on Apple (AAPL). He or she could sell the existing position and purchase the February 2021 130 calls. This would be an example of rolling long calls.
Trades like this can be executed in a single transaction to lower commissions.
Next, there are several types of options strategies. Investors can be short calls or short puts. In those cases they would roll their options by doing the opposite — buying the short call or put and selling a similar contract.
The purpose of rolling is to adjust an existing position. The new position keeps the same directional bias and structure.
Traders roll options because contract values can change dramatically over time.
Options are different than stock because they expire and you can’t hold them forever. They either expire worthless or result in a long/short position in the underlying security. Rolling options helps avoid that outcome.
Second, options behave differently based on movements in the stock. Profitable trades result in calls or puts gaining significant value and moving deep into the money. (For example, an option purchased for $0.50 can appreciate to $5.) While this is good news for the investor, the appreciated option is typically less liquid. Rolling options help remedy that situation.
The main reason why traders roll options is to lock in profits. Let’s take Snap (SNAP) as an example given its huge move lately.
Say you had bought the January 2021 40 calls in October 2020, before its big rally. At the time, those calls cost about $0.50.
SNAP has gained more than 80 percent since then as its stock spiked from about $28 to $52. Because the calls have leverage, they’ve appreciated more than 2,700 percent to roughly $13.
A trader could roll the position by selling the January 2021 40 calls and buying the January 2021 55 calls. He or she would get about $13 from the sale and pay about $1.80 for the new contracts. That would let them lock in a profit of $11 immediately and leave them positioned for more gains if SNAP keeps running.
Those SNAP calls have the same expiration date in January 2021. Traders can also extend their time frame by rolling options to a different expiration date.
For example, you could sell the January 2021 40 calls for $13 and purchase the June 2021 60 calls for about $6.80. That would lock in about $6 of profit and provide an additional five months for the stock to keep moving.
Alternately, an investor might want more time in a position that hasn’t appreciated much. Consider a stock like Microsoft (MSFT), which has barely moved since September 2020.
Say he or she had bought the January 2021 230 calls for about $4 in late October 2020, looking for a bounce. Because of time decay, those calls have depreciated to about $2.70 — even with MSFT shares gaining over the same period.
The investor could roll the January 2021 230 calls to the February 2021 230s, which now cost about $7.15. They’d pay about $4.45. (That’s $7.15 minus $2.70.) The good news is that rolling would let them salvage most of their initial cost.
Even more important, it would protect them against the accelerating time decay that occurs near the end of an option’s life. January expiration is less than a month away, which means theta will increase in the existing contracts. Rolling to February will reduce that risk of time decay.
Calls fix the level where a stock can be purchased. Long calls appreciate when prices rise. Investors sometimes own calls instead of shares because they require less cash. If the stock rallies, the leverage can deliver even greater gains than owning the stock.
They can roll them over time as the shares appreciate, locking in profits along the way and managing time decay.
Puts fix the price where a stock can be sold. They’re the opposite of calls because they appreciate when prices fall.
Investors can use puts to hedge other positions. When expecting a decline in stocks overall, they might buy puts on an ETF like the SPDR S&P 500 ETF (SPY), which tracks the broader market. Traders can also buy puts instead of short selling a stock. (That’s when they look to profit from an expected price decline.)
Either way, puts can gain value as markets move lower. Investors can roll puts the same way they’d roll calls, taking profits and managing time decay. The only difference is that they’d take profits by rolling to lower strikes instead of higher strikes.
A covered call is a lower-risk options strategy that entails holding shares and selling (or “writing”) calls against them. Investors use this technique when they like a company but want to reduce the risk of owning stock.
The calls sold lose value because of time decay. Therefore, investors can roll covered calls by purchasing the short calls and selling other contracts with later expirations.
For example, say you own 100 MSFT shares and sold 1 January 2021 240 call on November 5, 2020. At that time, the calls were worth about $5. By late this month, they were quoted for under $1. (Remember the stock has barely moved since the summer.)
You could buy the January 2021 240 calls and write the February 2021 240s for about $4.10. That would generate an incremental credit of more than $3. Traders can repeat similar transactions each month to bring in additional cash and lower the cost basis in the stock.
Disclaimer: These examples are intended for educational purposes only and shouldn’t be considered recommendations.
Options trading is not suitable for all investors. Your TradeStation Securities’ account application to trade options will be considered and approved or disapproved based on all relevant factors, including your trading experience. See Characteristics and Risks of Standardized Options. Visit www.TradeStation.com/Pricing for full details on the costs and fees associated with options.
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