Rolling Option Trades:
It is only a matter of when, not if a trade will move against you and challenge your strike. Despite being disciplined and selling options with high IV rank while following the 10 rules of option trading, trades will be challenged, and some losses are inevitable. However, as part of a holistic option portfolio management strategy, some of these potential losing trades can be managed effectively to circumvent losses altogether via rolling trades. Given the right set of circumstances, rolling an options trade can be performed by closing out the pending trade for a debit and subsequently opening a new trade with a later date and further out-of-the money strikes for an overall credit.
What is Rolling?
Rolling trades is a mitigation strategy that is deployed when an option’s strike leg is breached. Once the strike is breached, potential losses come into play. Rolling a trade involves closing out the pending trade that is challenged for a debit and then opening a new trade for a credit. The net credit received will negate the debit required to close out the initial trade while providing net premium income. The new trade will be in the same underlying security but later dated with further out-of-the-money strikes. This rolling strategy provides more time and more of a buffer in the stock price movement while circumventing the loss.
Why Roll Trades?
A statistical edge or probability of success is on your side when selling options that are out-of-the-money. This statistical edge is jeopardized when the strike price is breached, and the probability of success is no longer in your favor. This statistical edge must be reset by rolling a trade to reestablish this edge to your advantage. Rolling out to a later date and further out-of-the money strikes will reestablish this statistical edge and allows more time for the trade to work through the unexpected price excursion.
Initial Trade is Key:
Each initial option trade should be structured in such a way that enables the ability to roll the trade in the event the trade is challenged during the option lifecycle. Initial trade structure is imperative so rolling can easily be a viable option if needed.
Initial strike width selection needs to be narrow. If the strike width is too wide and the trade breaks down well below the protection leg, then the debit required to close the trade will be too great to overcome with a new credit without being over-leveraged in that trade. Rolling a trade is a last resort lever to pull so allow the trade to mature as close as possible to its expiration date. This will allow mean reversion to possibly take place and retrace back to out-of-the-money territory so rolling can possibly be avoided altogether.
Dangers of Rolling:
When a trade breaches the strike price, one must be careful not to overleverage the amount of capital dedicated to the rolling trade. The underlying security may continue to move against your directional trade thus allocation discipline is key. You do not want to dedicate too much capital, nor do you want to continue to allocate capital to a losing trade. Often, absorbing the loss may be the most prudent action if the initial rolling of the trade failed to circumvent losses. Continuing to roll the trade to overcome the debits required to close out the preceding trade(s) will require more leverage in one’s portfolio. This can be a dangerous cycle since strike widths will likely need to be widened and/or the number of contracts will need to be increased. These two elements will require more capital and potential for larger losses than initially set forth.
Two Examples (Mastercard and FedEx):
Rolling decisions are made based on data and circumstances available at the time of that decision. In hindsight, rolling a trade may not have been necessary when expiration comes to fruition. Often, more patience is required to allow the trade to unfold further into its option lifecycle. Hindsight is always 20/20 however based on the stock movement, strike price being breached and statistical edge no longer in one’s favor, rolling is the best way to reset the statistical edge in your favor. Mastercard (MA) and FedEx (FDX) were two trades that I rolled however in hindsight both trades would have expired worthless anyway so rolling was not needed.
A put spread on MA was sold with a $295/$290 and then rolled out a month to a further out-of-the money $275/$265 strike pair. At the original expiration date and strike of $295, the trade moved back to out-of-the money and would have expired worthless, so the realized profits were pushed out a month due to rolling the trade. The initial trade was closed for a debit of $632 and the new trade was opened for a credit of $806 thus still generating $173 in net premium profit.
A put spread on FDX was sold with a $250/$240 and then rolled out a month to a further-out-of-the money $230/$220 strike pair. At the original expiration date and strike of $250, the trade moved back to out-of-the money and would have expired worthless, so the potential realized profits were pushed out a month due to rolling the trade. The initial trade was closed for a debit of $703 and the new trade was opened for a credit of $882 thus still generating $180 in net premium profit.
In these cases, rolling was not necessary however this allowed for the statistical edge to be reestablished and provided breathing room in trades that were challenged during the option lifecycle unfolding. Profits were still realized albeit a month postponed.
Rolling can be an effective mitigation strategy when faced with a challenged strike price. An option’s statistical edge must be reset by rolling a trade to reestablish this edge to your advantage. Rolling out to a later date and further out-of-the money strikes allows more time for the trade to work through the unexpected price excursion. Often, more patience is required to allow the trade to unfold further into its option lifecycle prior to deciding on rolling a trade.
Founder and Managing Member
Stock Options Dad LLC
A Registered Investment Adviser (RIA) firm