Rules for Rolling Your Options Position

05/07/2010 12:01 am EST


Mark Wolfinger

Educator, MDWoptions

Rolling a position occurs when a trader moves (or "rolls") a position from one option series to another. In the case of a spread trade, all options in the position are moved from one option series to another. This is a popular strategy, but many traders roll for precisely the wrong reasons.

Let's look at an example in which a trader rolls a position in an attempt to turn a losing position into a winner.

Example: XYZ is trading near $49 per share, so the trader sells five XYZ November 45 puts at $1.50, or $150 per contract.

Time passes and it's early November and XYZ has declined to $43. This trade is underwater. Not being one to panic easily (or be too concerned with risk management), this trader now decides it's time to do something about this losing trade.

Roll: Our trader enters a spread order to buy to close five XYZ November 45 puts at $3 and sell to open five XYZ January 40 puts at $2. The more conservative roller pays $100 to make this trade (November puts cost $300 per contract minus the $200 premium brought in from selling the January puts).

Combining the cash from both trades, the trader has collected a total of 50 cents for each put. The January 40 put is trading at $2 and the trader is net short that option at 50 cents. Obviously this trade is losing money, but the hope is that the option is out of the money and will remain that way.

That's how most people think when rolling a position. They're still losing money, but at least they have a better chance to get back to even on the “whole” trade.

The more aggressive roller, wanting to take in extra cash when rolling the position, may choose to sell eight (or more) XYZ January 40 puts instead of five. 

Trade: Buy five XYZ November 45 puts at $300 per contract and sell eight XYZ January 40 puts at $200 per contract. The net cash collected is $100, less commissions.

The typical mindset for a trader who is rolling a position is:

  • I refuse to lock in a loss by closing the trade
  • I want a new position that gives me the chance to get back all the money I am currently losing
  • I want less risk than I have now, but if I have to sacrifice something to make the trade, then I'll sacrifice risk management
  •  I prefer to collect cash when making this trade

The basis for this mindset is:

  • Why should I take a loss when I can avoid it?
  • I know the market can't go in this direction much longer?
  • Sure it's nice to reduce risk, but I'm losing money and cannot be bothered with risk
  • I'll show them. "They" won't give me my deserved profit now, so I'll make even more later

This mindset is destructive. In search of a profit at any cost, the trader takes on too much risk, loses too much money, and simply owns inappropriate positions.

It is not essential to roll a position. It's OK to exit and take a loss.

The Right Time to Roll a Position

When is it appropriate to roll? When two conditions are true: 

1. The current position is not worth holding and you want to exit

2. The position to which you roll is something you want in your portfolio. In other words, it's a trade you would make even if it were not the result of a roll

It's truly foolish to enter into a new trade just to try to prevent taking a loss. The truth is you take that loss when you roll the trade. The old position has been closed. The loss is locked in, but there is an illusion that the trade is "still alive" because it has been rolled.

Think back to the example above. The trader’s thought that he would short the January puts at 50 cents when they were sold at $2. The traditional roller thinks, "I'm out of the original options, but the position is still working for me, although I am not in this one at a good price. But it's the same trade and I may still earn a profit."

Often the roller is desperately looking for a way to salvage the trade and initiates a new position that is both too risky for the possible reward and too unlikely to earn any money. In other words, out of the frying pan into another frying pan.

Rolling a Winning Position

Rolling a profitable trade, on the other hand, can be a good strategy. If the investor is long a put option and the market is falling, the trader may prefer to lock in a profit by selling the now-profitable option and buying another with a lower strike price. That maintains a position with profit potential, but it also locks in a profit in case the market reverses.

Any option position can be "rolled," yet this strategy is often used by traders who find themselves in the uncomfortable situation of owning a losing trade. Don't make that mistake.

By Mark Wolfinger of Options for Rookies

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