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On Options

Know When to Roll ‘Em: How to Roll Options Positions

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If you are an option trader perhaps you’ve found yourself in the following situation: its expiration day, your stock is trading right around the strike price of your short call and you are concerned about being assigned. You could wait until the market closes to see where the stock closes and you will either be assigned or the call will expire worthless. Alternatively, you could buy back the call and close out the obligation, or you could roll out the call to a different expiration and/or strike price before the market close. Not sure what rolling an option contract means? In this article we will cover the basics of options rolling and walk through a couple of examples which should help you understand this basic options strategy.

What is a Rollout?

In general terms, an options rollout strategy involves the simultaneous closing of one option contract and opening of a different contract of the same class (call or put). The new contract opened can be a further-dated expiration (the option would be rolled “out”), higher strike price (rolled “up”), lower strike price (rolled “down”) or a combination of both a different expiration and strike. Rollouts can be done on long or short single-leg options positions or multi-leg positions such as spreads and straddles.

Why roll out an option?

Rollouts can be performed on either long or short options positions but most of the time they are done on short options positions and they are typically initiated around expiration. Options traders often perform a rollout around expiration to avoid assignment on in-the-money options, to continue generating income or to adjust an existing position to reflect a revised outlook on the underlying stock. Covered calls and Cash-Secured Equity Puts are probably the two most common options strategies for rollouts.

Covered Call Rollout Example

Let’s assume that you established the following buy-write position:

• Bought 100 shares of XYZ for $103.00
• Sold to Open 1 XYZ 10/21/2016 105.00 Call for $1.50

The total cost of the position is $10,150.00 excluding commissions ($10,300 for the equity position minus the $150.00 received from selling the call). Now let’s fast forward to October 21st where XYZ is now trading at a price of $105.73. If you do nothing in all likelihood you will be assigned on your short call and have your 100 share XYZ position called away at a price of $105.00. On the other hand, if you want to avoid assignment you can perform one of the following actions:

  • Buy-to-close the short call position to eliminate your obligation
  • Roll the short call position to a further-dated expiration and to the same or different strike price

Note: while closing out the entire covered call position (i.e. Unwind) prior to market close is an available choice, in this example it probably doesn’t provide any benefit since you will likely be assigned on your short call. Of course, it’s always a possibility that the price of the underlying drops back below the strike price by the market close.

Let’s assume that you are still moderately bullish on XYZ and don’t want to be assigned so you decide to roll your short call out (to a further-dated expiration) and up (to a higher strike). This way you can maintain your position in XYZ, bring in some additional income and still leave some room to the upside before assignment becomes a concern again. Therefore, you launch Schwab’s StreetSmart Edge platform and perform the following actions:

  1. Launch the “All in One Trade Tool” and select the “Rollout” strategy
  2. Buy to Close the XYZ 10/21/2016 105.00 Call (note: your position will automatically populate for you in the trade ticket when you have an existing position)
  3. Sell to Open a new call of your choice – in this example the XYZ 11/18/2016 110.00 Call

Trade Ticket

Source: StreetSmart Edge

As you can see from the trade ticket above, the 105.00 call has an ask price of $0.77 and the 110.00 call has a bid of $1.87, which means the rollout would bring in a net credit of $1.10. Of course the $1.10 represents the market price and the bid/ask spread is $1.10 x $1.21, so you may be able to get a slightly higher credit by adjusting your limit order higher, but for simplicity we will assume the order is executed at a $1.10 credit (excluding commissions). Now let’s take a look at how this adjustment affects the profit and loss on your combined position:

  • Sold to Open 1 XYZ 10/21/2016 105.00 Call: + $150.00
  • Bought to Close 1 XYZ 10/21/2016 105.00 Call: - $77.00
  • Sold to Open 1 XYZ 11/18/2016 110.00 Call: + $187.00
  • Total profit/loss: $260.00

In addition to the $260.00 premium received from the options transactions, XYZ has moved from $103.00 to $105.73 so you have an unrealized gain of $273.00 from the price appreciation in the underlying stock. As a result of the adjustment, your unrealized profit and loss on the position is $533.00 ($260.00 + $273.00), you maintain your 100 share position in XYZ and you have moved your covered call position out to the November expiration and up to the 110.00 strike.

Spread Rollout Example

Rolling out a spread is similar in concept to the covered call example but the process involves a total of four legs rather than two. And since a spread consists of two contracts instead of one, the rollout allows for more possibilities - not only can you roll your spread out, up or down, but you can also increase or decrease the spread width (i.e. the distance between the strikes). However, there can be many more reasons for rolling out a spread when compared to a covered call rollout. For example, you might roll an existing spread up or down if the underlying price has moved significantly in one direction and your outlook has changed as a result. Or perhaps you want to roll your spread out to a further expiration in order to give the underlying stock more time to make its anticipated move higher or lower. Regardless of the reason, a spread rollout is generally initiated because an adjustment to the original position is desired. Now we will walk through an example of a spread rollout to help understand the mechanics of this strategy.

Let’s assume that you started with the following Bear Call Spread:

  • Sold to Open 1 XYZ 9/16/2016 55.00 Call for $3.00
  • Bought to Open 1 XYZ 9/16/2016 60.00 Call for $1.00

The initial credit brought in from this spread is $200.00 ($3.00 credit from sale of the 55.00 call minus the $1.00 debit from the purchase of the 60.00 call x 100) excluding commissions. At the time of the trade XYZ was trading below $55.00 but as expiration nears you find that the stock has moved against you and is now trading at $56.63. If you wanted to you could close the spread out right now but since you still feel confident in your bearish stance and believe that the upside in XYZ will be limited, you decide to roll your spread out (to the 10/21/2016 expiration) and up (to a 60.00/65.00 strike range). Bringing up Schwab’s StreetSmart Edge platform you perform the following actions:

  1. Launch the “All in One Trade Tool” and select the “Rollout Spread” strategy
  2. Buy to Close the XYZ 9/16/2016 55.00 Call and Sell to Close the XYZ 9/16/2016 60.00 Call (note: your position will automatically populate for you in the trade)
  3. Sell to Open the XYZ 10/21/2016 60.00 Call and Buy to Open the XYZ 10/21/2016 65.00 Call

Trade Ticket

Source: StreetSmart Edge

Using the market prices from the trade ticket above, you can see that the initial spread is going to cost $225.00 to close out ($3.30 debit from the purchase of the Sep 55.00 Call plus the $1.05 credit from the sale of the Sep 60.00 Call x 100), but the new spread will bring in a credit of $95.00 ($3.10 credit from the sale of the Oct 60.00 Call minus the $2.15 debit from the purchase of the Oct 60.00 Call x 100). The net debit for this rollout comes out to $130.00 excluding commissions. Here is a breakdown of the initial spread, the adjustment and resulting credit:

  • Initial Credit from Bear Call Spread: + $200.00
    • Sold to Open 1 XYZ 9/16/2016 55.00 Call for $3.00
    • Bought to Open 1 XYZ 9/16/2016 60.00 Call for $1.00
  • Cost of closing out initial Bear Call Spread: -$225.00
    • Bought to Close 1 XYZ 9/16/2016 55.00 Call for $3.30
    • Sold to Close 1 XYZ 9/16/2016 60.00 Call for $1.05
  • Credit from opening new Bear Call Spread: +$95.00
    • Sold to Open 1 XYZ 9/16/2016 60.00 Call for $3.10
    • Bought to Open 1 XYZ 9/16/2016 65.00 Call for $2.15
  • Total credit as a result of the adjustment: $70.00

As you can see from the transactions above, the rollout result is a net credit of $70.00 rather than the $25.00 loss which would have been incurred from simply closing out the spread. On one hand, you have given yourself an opportunity to turn a losing trade into a profitable one. On the other hand, you will need XYZ to stay below $60.00 by the October expiration in order to retain the full $70.00 profit.

Benefits of Rolling Out

Since a rollout is conducted in one transaction rather than two, you will only be charged one base commission (along with the per contract fee). While this shouldn’t necessarily be a reason to roll any options position (which should primarily be driven by your outlook on the underlying), the savings can add up over time if you are a frequent options trader. Another benefit of rolling is that by simultaneously closing and opening your options position, you avoid the risk of “price slippage” which can occur during the time between separate closing and opening transactions.

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