How To Roll An Option

Are your options moving on the opposite direction of what you expected? Are they now out of the money and the expiration date fast approaching? Or are they exceeding your expectations and are behaving better than you expected and you want to earn more?

In these cases, you may have enough reason to believe that your option is going to eventually make a U-turn to your initial direction even if the option is currently going against you or your option will continue to move on your initial direction. You could end up winning more eventually but you face one big problem: TIME. Your option is about to expire.

Remember that all options have expiration dates and are bound to expire sooner or later. But there is a way to overcome this so that you can escape your current losing position or continue building up your profit.  You can Roll the Option from One Month to Another.

Roll Forward Defined

Rolling an option from one month to another is also called roll forward. Roll forward is the act of extending the expiration or maturity of an option.

Whether you are in an open long position or in an open short position and whether the option is a call or a put, you can roll your option from one month to the next. But to make things simple, we will assume in our examples that you are in an open long position for a call option.

The Steps to Roll Forward an Option

Rolling forward an option takes only two easy steps.

First, close out your existing option position. This means that you sell your previously bought call option.

Next, open a new position for the same option but with a later expiration date. This means that you need to buy the same option with a longer expiration date.

When you open a new option position, you may open one with a higher, lower or the same strike price as the previous option. Opening a new position with a higher strike price is called rolling up while opening a new position with a lower strike price is called rolling down.

Most option platforms contain the feature called “roll” which gives the option trader the convenience to simultaneously open and close an option position for a later date in just a single order.

How Rolling Forward Can Be Advantageous

Rolling forward can help you to escape a losing position and / or building up more profits.

Escaping a Losing Position

Let us assume that last January 28, the shares of ABC, a cellular phone manufacturing company, were selling at the market for $50. You forecasted that the stock price of the corporation is going to rise to about $60 by next month because the company is scheduled to announce its new series of cellular phones in the middle of February which would normally boost investor confidence and cause the stock price to rise. So you purchased a call option with a strike price of $54 that would allow you to buy 100 shares of ABC Corporation for a premium of $200 with the expiration date on February 22.

On February 20, things don’t seem so good because ABC Corporation has not made any announcement about their new cellphone series and refused to release comments about its status. Investors started to lose confidence thinking that there might have been serious problems with the new cellphone series. This has caused the stock price to fall to $45 and you only have two days before the expiration date!  Chances are, you are in for a loss of $200 (the premium you paid).

In this situation, you can roll your option to next month. Let us say that you still have hopes that the company is going to announce its rolled your option to next month. You sold your Feb 22 option for only $50 and bought a March 22 for a strike price $54 option for $150. Your net cash out now is $300 (200 – 50 + 150).

On March 15, ABC Company finally announced its new cellphone and series and the new series turns out to be built using state-of-the-art technology. .Hence, the stock price rose to a staggering $70 and you decided to exercise the option right away and sold them out in the market at the market price. You received a net credit now is $1300! (7000 – 5400 – 300)

Building Up More Profits

This time let us assume that on February 20, the corporation still has not made an announcement about its new cellphone series. However, investors did not lose confidence despite the situation. The stock price of ABC  Corporation even rose to $57. At this point, if you exercise the option, you can already gain a net credit of $100 (5700 – 5400 – 200). But what if the corporation makes the announcement after the expiration date and the stocks rose some more? You could have also earned some.

You can do both by rolling forward your options. Let us say that you sold your Feb 22 option for $400 and bought a March 22 option with a $54 strike price for $100. At this point, you already have a net credit of $100 ($400 – 100 -200) which you can already pocket. When the corporation makes a public announcement before March 22 and the stock price rises to $70, you can earn an additional $1600, giving you a total profit of $1700!

Hence, with rolling forward, not only were you able to escape from a losing position but you were also able to win a large amount of profit or continue building the profits you already earned.

Bottomline

Although rolling an option forward can extend your profits, there are instances when it can also extend your losses. Always take caution in rolling forward your options.