Options trading roll forward
The intention is to avoid or delay exercise when the option has gone in the money or threatens to before expiration. In theory, a writer can roll forward indefinitely, avoiding exercise until the short option remains out of the money at expiration. This strategy is especially attractive for covered call writing, because the market risk in the short position is minimal compared to uncovered call or put writes.
Secondly, the forward roll at the same strike produces additional income because a later-expiring option is always more valuable than an earlier-expiring option. This is due to the nature of time value, which is higher for longer expiration terms.
For call writes, a variation on the strategy is to replace the current short position with a later-expiring, higher-strike call. This may involves a smaller credit or even a debit. Call writers assess the value of the higher strike roll by comparing the net cost to the additional strike value. If the subsequent covered call is not exercised but ends up getting replaced, the loss could become permanent. For example, if the writer decides to c lose out the This is an example of how covered call writers can deceive themselves through excessive use of the forward roll, and create net losses without intending to.
The forward roll is a valuable strategy, but there are times when it makes more sense to roll to the same strike and gain a small profit, or simply accept exercise on the position. The pitfalls of the forward roll The potential for creating an unintended loss is only one of the dangers in utilizing the forward roll. Part of the assessment of any strategy should balance benefit against risk — and risk includes continued exposure in a short position.
Does the potential exercise avoidance justify the added time the short option remains open? The risk is not limited to potential exercise of a short option. Rolling forward keeps you committed in the position, meaning more capital tied up to maintain margin requirements, also translating to the potential loss of other opportunities between now and expiration of the short option.
Any option writer needs to continually keep the overall net profit or loss in mind, and to analyze the current position in terms of the time element as well. So in considering a forward roll, do you want to move the open period out later than two months? This is always possible to avoid exercise, and the further out you go, the more you are able to roll up and still create a credit.
However, that always means the covered position has to remain open much longer; and this is where your judgment has to come into play. It should always be worth the extension of risk and exercise avoidance, or rolling forward does not make sense. Many covered call writers end up forgetting that exercise should be an acceptable outcome.
In fact, when properly structured, exercise is a highly profitable outcome, given that profits come from three sources option premium, capital gains and dividends. At times, it makes the most sense to let exercise happen and then turn over the proceeds in another position. Rolling the short put Forward rolling also works for short puts. In this situation, you avoid exercise by replacing a current short strike with one expiring later. To increase potential profits or reduce potential losses in the event of exercise, you can roll forward and down to a lower strike.
The same caveat applies to short puts as that for short calls: Make sure you evaluate the time commitment risk along with the net credit or debit of the forward roll. Whenever you short a put, one possible outcome is exercise, meaning shares will be put to you at the fixed strike. This makes sense only when you consider the net cost of buying those shares is a price you think is fair. However, you still want to avoid the forward and down roll if the cost is going to represent added expense and an unacceptably longer time the short position has to stay open.
Unqualified covered calls A final risk involved with rolling covered calls forward involves the complexity of federal tax law. If closing the position includes exercise, then the capital gain will be short-term, even if the overall holding period is longer than one year. For example, if you bought stock nine months ago, you have only three months to go before any gains will be long-term. At this point, you have a point gain on the stock, and you decide to write a deep in-the-money covered call.
If you want to roll up an entire options spread, then this can involve several transactions and can be somewhat complex. Because of this, the roll up of options spreads isn't really something that beginner options traders should be considering. This technique is very much like to the rolling up technique, but effectively the opposite.
Instead of moving one position to a similar one with a higher strike price, it involves moving to one with a lower strike price. You still need to exit the existing position, and then you must enter the corresponding position using contracts that have a lower strike price.
Again, it can be applied to both short and long positions, and to both calls and puts. The top online brokers will also typically offer a roll down order, which effectively combines the two required orders into one.
There are three main reasons for using this technique, which would depend on what position you currently have and what the circumstances are. These three reasons are as follows:. To prevent assignment on a short put position. It can be used to avoid assignment if you have written puts that have moved into the money and you want to avoid the obligation of having to buy them. To take profit on puts and speculate from further downward movement.
If you owned puts that had moved deep in the money, you could roll down to take the profit from those options and purchase puts with a lower strike price. This would allow you to benefit from a further fall in the underlying security without risking the profit you have already made. To cut losses on calls and speculate on the underlying security recovering. If you owned calls that were significantly out of the money due to the price of the underlying security falling, but felt that the underlying security may rally and their price may increase again, then rolling down is useful.
You can cut your losses on your out of the money calls, and then buy calls with a lower strike price that have a better chance of returning a profit if the underlying security does start to increase in price. When options you own or have written are reaching their expiration point there are a number of things you can choose to do depending on the circumstances. If you own options that are in the money, then you may want to exercise them if you have that choice. Alternatively, you may wish to let them run until expiration and realize any profit at that point, or you can sell them to gain the intrinsic value and any remaining extrinsic value.
If you own options that are out of the money or at the money, then you could sell them to recover any remaining extrinsic value, or let them run until expiry and see if they gained any intrinsic value by that point. If you have short position on options that are in the money, then you could choose to close it to prevent any losses if they get any further in the money.
Alternatively, you could choose to let the contracts run until expiry to benefit from any remaining extrinsic value and hope they get nearer the money or fall out of the money. You have another choice for your open positions where the options involved are nearing the expiration date, and that is to roll forward. This technique is used for moving a position to a different expiry date to extend the length of time it has to run.
You basically close an existing position and open a corresponding one based on the same options, just with a later expiration date. It's also known as rolling over. As with the two previously mentioned techniques, rolling forward can be done by simultaneously exiting the existing position and entering the new one using a specific order.
If your broker offers it, then it may be advantageous to execute the transactions separately. You could either enter the new position first and then close the existing one, or exit the existing position first and enter the new one after. There are two primary reasons for using this technique. The most common is if you entered a position expecting to profit from a short term price movement, but now you expect that price movement to be over a longer period of time than expected.
For example, you might have bought calls on an underlying security that you were forecasting to increase in price for a specific period of time. If you then believed that it would continue to increase in price for a longer time, you would extend the length of your position to a later expiration date, enabling you to continue to profit.
The second reason is if you entered a position expecting the underlying security to move in a certain direction within a certain time frame, and then realized that it was going to take longer than expected for the underlying security to move as anticipated.
You would extend the length of time available to try and profit from the expected move. The basic concept of all three rolling techniques is relatively straightforward; the difficulty comes with knowing when to use them at the right times. They are definitely techniques you should be familiar with, because there will almost certainly be occasions when using them is a good idea.
It's important to be flexible when trading options, and if you ever feel that you need to adjust a position slightly, rolling could be the best way to do that. Rolling in Options Trading Rolling is a fairly common technique in options trading, and it has a variety of uses.