Rolling an Option Position

This post originally appeared at the Options Zone, 5/3/2010


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Rolling a position is the topic of an upcoming webinar. The tentative date is June 15, 2010 and the webinar is presented by TradeKing.

Rolling a position occurs when a trader moves, or rolls, a position from one option series to another. When a spread is being rolled, then all options in the position are moved from one option series to another.

Here's an example in which a trader rolls a position in an attempt to turn a losing position into a winner:

Example: XXZ is trading near $49 per share

Sell 5 XXZ Nov 45 puts @ $1.50

Time passes and it's early November. XXZ has declined to $43, and 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:

Buy to close 5 XXZ Nov 45 puts and sell to open 5 XXZ Jan 40 puts.

The more conservative roller pays $1.00 to make this trade (Nov 45 puts cost $3 and the Jan 40 put can be sold @ $2)

Combining the cash from the original trade and the new trade, the trader has collected a total of $0.50 for each put. The Jan 40 put is trading @ $2 and he/she is net short that option @ $0.50. 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. It still losing money, but at least they have a better chance to get back to even on the 'whole trade.'

The more aggressive roller wants to take in extra cash when rolling the position and may choose to sell 8 (or more) Jan 40 puts, instead of 5. Trade: Buy 5 XXZ Nov 45 puts @ $3 and sell 8 XXZ Jan 40 puts @ 2. Net cash collected $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

What's the basis for this mindset?

  • Why should I take a loss when I can avoid it
  • All I want is a chance. I know the market cannot 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 money later

I believe everyone understands this is not a healthy way of thinking. Sure, if it all works out well in the end, you get that satisfied feeling. I'm a strong believer that feeling happy when trading is a big benefit to the trader. Losses, and the stress that comes with them, do not make for happiness. You should do all you can to remain confident that you know what you are doing and that you have the skills necessary to become a winning trader.

But it's far more important to face the truth. Not everyone can earn money as a trader. It's important to maintain good discipline and excellent risk management skills to succeed in the trading world.

A mindset such as the one above is destructive. It search of a profit at any cost, the trader takes too much risk, loses too much money, and simply owns inappropriate positions. It's not essential to roll a position. It's okay to exit and take a loss instead.

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

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

The position to which you roll is something you want in your portfolio. 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 – when you don't want to own it – 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. Just as the example illustrates a trader's though that he is short the Jan puts at $0.50 when they were sold at $2, that's the way a 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.

 

Winners can also roll a position

Rolling works for profitable trades. 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 when the market reverses. This trade is also rolling a position.

Any option position can be 'rolled.' Yet, the common perception is that this strategy is used only by traders who find themselves in the uncomfortable situation of owning a losing trade.

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