Understanding Option Rolling: What It Means and How It Works

Rolling an option might sound complex, and it did to me when I first came across the concept, but once you do it once, it’s easy to understand. The tricky part is knowing when to roll an option, and this is more an art than a science. 

what is rolling an option

Table of Contents

What is Rolling an Option?

In simple terms, rolling an option means buying back your original position and selling to open a new position. 

When you roll an option you really want to do it in order to improve your position. 

Let’s look at a real-life trade I did in PayPal, ticker symbol $PYPL.

Position: On the 15th of September, 2023, I sold to open the \$64 cash-secured put option in PYPL with the 22nd September expiration. 

At the time the stock was trading at $64.20/share and looked like it had bottomed (or so I thought). 

I was paid $0.55/share for doing this trade. So $55 total excluding commissions. 

On the 20th of September PYPL was trading at $60/share and my short put option was now in-the-money $4/share. 

I wasn’t ready to be assigned my shares at $64 when they were now trading at $60 so I decided to buy myself more time to be right by rolling my put option down and out. I did this trade for a net credit.

So what happened next? 

Roll Number 1: On September 20th I bought to close my $64 put option and sold to open a new put option with a $63 strike price, and expiration one month away. I did this for a net credit of $0.20/share, so $20 in total premium. 

Why did I do this? 

I felt that by kicking the can down the road a month PYPL would have a chance to recover and my new put option would expire worthless. 

Fast forward to October 4th, and PYPL was still declining. It was now trading at $58/share. 

So I decided to roll again. 

Roll Number 2: I bought to close my October 20th $63 cash-secured put option and sold to open the December 15th $61 cash-secured put option. I did this for a net credit of $0.81/share, so $81 in total premium. 

In summary:

  • Originally sold a $64 put for $55 premium when PYPL was trading at $64.20 per share.
  • Stock declined so rolled to $63 put on Sept 20 for $20 credit when stock was $60 per share. 
  • Stock kept dropping so rolled further down in strike to $61 put on Oct 4 for $81 credit when stock was $58 per share. This $61 put option now expired on December 15th. 

The key drivers for each roll were:

  • Avoid assignment at higher prices as stock declined
  • Collect more premium credits each time to lower cost basis
  • Give more time for potential upside recovery

When Should You Roll An Option Position?

Typically, when to roll a covered call and cash secured put option differ slightly. 

For instance, you want to roll a cash-secured put option really when:

1) You want to avoid assignment on the current contract

2) There’s still time value remaining to capture

3) Market conditions have changed and adjustments are needed.

4) You can improve the position’s profitability or lower your risk.

The key triggers are avoiding assignment, capturing residual value, adapting to new conditions, and optimizing your P&L.

When it comes to covered calls, you really want to roll them when: 

The underlying stock price rises significantly and is near the strike price. Rolling allows you to lock in gains on the shares while selling another call at a higher strike for more premium.

How I Use Time Value When Rolling My Short Put Options

The key consideration when deciding to roll an option is preserving remaining time value. I typically look to roll my positions when there is 10-20% of time value left. You want to roll before extrinsic value erodes to zero, which risks early assignment.

Rolling out to a later expiration also allows you to benefit from time decay – selling longer-dated options locks in higher premium thanks to added time value.

However, there will be cases where the share price drops below your strike so rolling is pointless or locking in a loss. Here you have to be prepared for assignment and transition to writing covered calls.

That is why carefully selecting quality underlying companies from the outset is crucial – you want to avoid being assigned a potential penny stock.

In essence, monitoring how much extrinsic value is left guides optimal timing on when to roll positions. The goals are to maximize captured time value from the original sale while still providing additional time to be right directionally. Rolling proactively positions you to meet both those objectives.

Hypothetical Case Studies: When Option Rolling Works and When It Doesn't

Here is a sample case study demonstrating a successful covered call roll:

Case Study: Rolling Up a Profitable Covered Call

Scenario: A trader owns 100 shares of ABC stock which they purchased at $50 per share. They sell a monthly covered call with a strike price of $55 and collect $1 per share in premium. By expiration, the stock price has increased to $65 per share.

Outcome: As ABC approached \$55, the trader rolls the covered call up and out by buying back the initial call and selling a new call with a $60 strike price and expiration 2 months out. This locks in additional gains up to $60 while pocketing more premium from the new call.

Lessons: Rolling up a profitable covered call allows traders to secure some profits while keeping upside exposure. By selling a new call at a higher strike and later date, more income is generated as well. Monitoring price trends is key to know when rolling makes sense.

Pro Tip:

When writing covered calls, it’s advisable to focus on a delta range of 0.15-0.25 if you wish to retain your shares while benefiting from potential upward price movements. Alternatively, consider selecting a strike price above the current resistance level on a chart.

Additionally, it’s worth exploring the option of selling covered calls when a stock is overbought, indicated by a reading of 70 or higher on the RSI indicator. Implementing these strategies can assist in holding onto your shares during a bullish market, allowing you to write covered calls and generate monthly cash flow.

Here is a sample case study demonstrating a successful cash-secured put roll:

Case Study: Rolling Down a Losing Cash-Secured Put

Scenario: A trader sells a monthly cash-secured put on stock XYZ with a $50 strike price and collects $1 per share in premium. However, XYZ stock drops to $48 instead of staying above $50 by expiration.

Outcome: To avoid having XYZ put to him at \$50 when it is trading at $48, the trader rolls the put by buying back the original put and selling a new put at the $45 strike with an expiration 2 months out. This roll captures additional premium while adjusting to the bearish trend in XYZ.

Lessons: Rolling a losing cash-secured put allows traders to avoid assignment at unfavorable prices. By rolling down in strike and out in expiration, traders can align with bearish trends, capture more premium, and wait for potential rebounds.

Here is an updated example case study incorporating your suggestion:

Case Study: Covered Call Roll Backfires in Volatile Market

Scenario: A trader owns 200 shares of stock ABC at $131 per share. They initially sell a monthly covered call at a $135 strike for $3 premium. Then ABC misses earnings and drops to $73, they attempt to roll their call down to a $80 strike expecting the stock to stay in the $73-$80 range until the next earnings release 3 months away. 

Outcome: Unfortunately the market volatility accelerates in the following weeks. The FED just cut interest rates and ABC stock surges to $140, leaving the trader’s covered calls deep in-the-money heading into expiration. The calls end up assigned and the trader is forced to sell their ABC shares at the rolled $80 strike, missing out on capturing the surge back to $140 and booking a huge loss on this trade.

Lessons Learned: When rolling covered calls on stocks that have dropped way below your cost basis, things can backfire pretty quickly if mr market swing against you. Be careful selling covered calls when stocks are trading way below your cost price. I also cover how to deal with these scenarios in my Options Selling Roadmap course as I have experienced it several times in my own portfolio.

Rolling Up, Down, and Out: What These Terms Mean

  1. Rolling Up: Rolling up refers to the process of adjusting an option position by moving to a higher strike price. Traders may choose to roll up when they anticipate a further increase in the underlying asset’s price.
  2. Rolling Down: Rolling down involves adjusting an option position by moving to a lower strike price. Traders may roll down if they expect the underlying asset’s price to decrease or to reduce potential losses.

  3. Rolling Out: Rolling out refers to extending the expiration date of an option position while keeping the same strike price. This technique allows traders to give the market more time to move in their anticipated direction.

By understanding these terms and techniques, traders can strategically adjust their option positions to align with their market outlook and risk tolerance.

Some Key Terms For Rolling Options

  1. Diagonal Rolls: Diagonal rolls involve rolling an option to a different strike price and expiration date simultaneously. This strategy can be used to capitalize on short-term price movements while maintaining a longer-term position.

  2. Calendar Spreads: Calendar spreads involve rolling an option to a different expiration date while keeping the same strike price. This strategy aims to take advantage of time decay by selling options with shorter-term expirations and buying options with longer-term expirations.

  3. Ratio Rolls: Ratio rolls involve adjusting the number of contracts when rolling options. Traders may increase or decrease the number of contracts to manage risk or potentially increase potential gains. I do these often when I am looking to take assignment of my shares but after capturing a lot of premium already. 

By incorporating these advanced strategies into your option rolling approach, experienced traders can enhance their ability to profit from various market conditions and optimize their risk management.

Why You Don't Need To Role

Ok options sellers—one of my most ironclad mindsets when selling options is to write short dated at the money puts on high quality stocks when they’re trading at fundamentally and technically attractive prices.

My aim is to work on adjusting my cost price on a stock I really like then either take assignment or buy the shares and then sell covered calls

Employing a value-focused approach with options puts you in the driver’s seat and allows for significant upside. 

This strategic methodology centered around options selling is covered extensively in my flagship course the Options Selling RoadmapWhether a seasoned veteran or curious novice, the course thoroughly grounds participants in time-tested principles and perspectives to conceive an adaptive options plan aligned with personal risk metrics and lifestyle desires.

In conclusion, option rolling is a valuable tool in options trading that allows traders to adjust their positions based on market conditions and trading objectives. By understanding the advanced techniques, strategies, and related trading approaches, experienced traders can enhance their ability to navigate the options market successfully.

Remember, option rolling requires careful analysis, risk management, and continuous monitoring. It is important to stay informed, adapt to changing market dynamics, and make informed decisions based on thorough research and analysis. With the right skills and knowledge, option rolling can be a powerful tool in maximizing profits and managing risk in options trading.

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Kevin S

Kevin S

Greetings, I'm Kevin! I am now a full time options trader and investor. I am thrilled to have the opportunity to share my knowledge and expertise with you. My objective is to assist you in navigating the complexities of option trading, regardless of whether you're a beginner or an experienced trader looking to enhance your skills. I'm excited to accompany you on your journey to mastering the art of option trading. Let's make this year an extraordinary one for you!
Kevin S

Kevin S

Greetings, I'm Kevin! I am now a full time options trader and investor. I am thrilled to have the opportunity to share my knowledge and expertise with you. My objective is to assist you in navigating the complexities of option trading, regardless of whether you're a beginner or an experienced trader looking to enhance your skills. I'm excited to accompany you on your journey to mastering the art of option trading. Let's make this year an extraordinary one for you!

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Welcome to Dividend On Fire, we are a site dedicated to options trading! We specialize in helping investors generate passive weekly or monthly income through selling cash secured puts and covered calls.

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