“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:
- What does it mean to roll options?
- Why do traders roll options?
- Rolling options to lock in profits
- Rolling options forward to extend time
- Rolling long calls
- Rolling long puts
- Rolling covered calls
What Does it Mean to Roll Options?
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.
Say an investor owns the January 120 calls on Apple (AAPL). He or she could sell the existing position and purchase the February 130 calls. This would be an example of rolling long calls.
Trades like this can be performed 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.
Why Do Traders Roll Options?
Traders roll options because their values can change dramatically over time. Unlike stock, options expire. You can’t hold them forever. They either expire worthless or result in a long/short position the underlying shares. 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 usually has much less liquidity. Rolling options help overcome that situation.
Rolling Options to Lock in Profits
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 40 calls in October, 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 40 calls and buying the January 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 them if SNAP keeps running.
Rolling Options Forward to Extend Time
Those SNAP calls have the same expiration date in January 2021. Traders can also extend their time frame by rolling options to different expiration date.
For example, you could sell the January 40 calls for $13 and purchase the June 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.
Say he or she had bought the January 230 calls for about $4 in late October, 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 230 calls to the February 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.
Rolling Long Calls
Calls fix the level where a stock can be purchased. Long calls to 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 in profits along the way and managing time decay.
Rolling Long Puts
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. If you expect a decline in the broader market, you might buy puts on the SPDR S&P 500 ETF (SPY). Traders also use puts as a substitute for short selling a stock. (They think prices are going to drop and want to profit.)
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.
Rolling Covered Calls
A covered call is a low-risk options strategy that entails holding shares and selling 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 240 call on November 5. 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 240 call and sell the February 240 calls for about $4.10. That would generate an incremental credit of more than $3. Similar transactions can be repeated 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 may not be suitable for all investors.