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“Rolling” An Option Position

Posted by Pete Stolcers on April 12, 2011

Option Trading Question

Rick S. asks, "I have seen you post comments that refer to "rolling" positions the week of expiration. What exactly is that?

Option Trading Answer

As option expiration approaches a trader has to decide what to do with front month positions. Even a long put option that will expire worthless provides some protection to the stock owner right up to “the bell”. That protection will have to be renewed to retain the risk profile. Given the accelerated time premium decay that occurs in the last week of expiration, most traders decide to sell the put while it still has some value. They apply the proceeds and defray the cost of buy one that has more time. This is called a “roll”. In this instance it could look like a calendar spread where the trader sells the front month and buys the back month (same strike price) for a net debit.

Let’s look at a speculative situation. Let’s say that I liked stock ABC and it was at $63. I own the June 60 calls the week of expiration and I still want to maintain the position. If I don’t want to buy the stock, I have to roll the options. I will sell the June 60 calls and buy the July 60 calls for a net debit of say $1.00. The “rolls” can be “down and out”, “up and out”, calendars… there are countless possibilities but in the end, they all maintain the desired risk profile that would be changed by expiring options. Traders that are short ITM options will roll to avoid assignment. The future month option has premium and the risk of assignment is reduced.

When I talk about “rolls” in the commentary I’m referring to institutional positions that can fuel a directional move. Let’s look at this expiration. Proprietary trading firms are always looking for risk less positions that yield a better than risk free rate of return (90-Day t-Bill). They have computer programs and floor traders on the CME/CBOE… They feed on tiny price disparities and they are always buying bids/selling offers. They leg and hedge continuously. The net affect of the activity is a stock position and an option position or a stock position and a futures position. This week the huge open interest in ITM OEX and SPX puts indicated that under the right conditions there might be additional selling pressure - here’s why.

The institutions may be long the OEX basket of stocks and long in-the-money (ITM) puts. It is a perfectly hedged position. If they are, they probably legged in at good prices and the trade simply needs to be “rolled” or unwound. As expiration approaches the options trade at parity (cash value). If the market is choppy and random, they will sell the puts and the stock at the same time. If they can roll the position at favorable prices they will do that, selling the June’s and buying the July’s. However, if the market gets into a predictable pattern the institutions will leg out of the position. They look for a day when the market has steady action in one direction. In this case, Monday and Tuesday were perfect and offered a steady drift lower. As the market declined in the afternoon, they sold their baskets of stock and drove the cash value of the index down. By the end of the day, they had sold their stock at higher levels and they exercised their ITM puts for cash. The cash value of the index was much lower and the cash they got for the puts was much greater. They effectively “goosed” the profits of a risk free trade.

It is important to watch the ITM open interest during expiration week. Often it might give you an indication of market bias. bear in mind the conditions that need to exist. I’m not against program trading. In fact, I’m all for it. It keeps the prices in line. Those that are against it weren’t complaining in March and April when it propelled the market to multi-year highs.

If you’ve have any examples of positions you’ve had to roll, please share.

Option Trading Comments

  • On 06/19, Richard Z said:

    This doesn’t really relate to the rolling of a position but a how does that happen. I was rolling from a June month contract to a July - same strike. I put in a order for a net credt of .45, which I was filled but the transactions did not trade on the nickels. Ie call was bought back at .54 cents and new was sold at .99.

  • On 06/19, Pete Stolcers said:

    Hi Richard,<br><br>Chances are your order was routed to the BOX exchange. If their bid and/or ask is the same as the other exchanges, they will often improve the fill by a penny to get the order. If you routed it, congratulations. If your broker routed it - kudos. They just saved you $20 (on a 10 lot spread). Many brokerage firms get paid for order flow so they have an underlying motive for their order routing decisions. Personally, I like to have the power to route to the exchange of choice. Often, I can’t get filled on one exchange, but I can on another even though the same bid/ask is showing on the screen. If the Market Maker knows the order is there to stay, they will lean on it and build in an "edge". That "edge" is worth a penny to them and they will pay the brokerage firm to "see" the order. If you can’t select the route, cancel the order if the stock is moving and you think you should be filled. You might see the bid/ask market change because your order was supporting it. You can re-enter it when you think the price is fair. Great question.

  • On 05/16, Mark said:

    Two questions about this article:

    1.
    “The institutions may be long the OEX basket of stocks and long in-the-money (ITM) puts. It is a perfectly hedged position.”

    Is this delta neutral trading?  If so, do you have previous articles discussing this?  Also, do you have information on neutral trading of options for credit spreads?

    2.
    “I was rolling from a June month contract to a July - same strike. I put in a order for a net credit of .45”

    Why do the net spreads go from a declining credit to a debit spread when ATM to ITM to DITM?

  • On 05/28, Pete Stolcers said:

    On a retail basis, delta neutral is more of a concept than it is a reality. Positions are delta neutral twice during the life of the trade, once when you put the trade on and once when you close it. Institutions are continually making markets and they do dynamically adjust positions. To read more about the strategy, please use the search engine on my blog and enter the words “delta neutral”.

    When you roll and OTM spread, you are collecting more premium because you are taking more risk by selling an option that is farther out in time. As you go DITM, the bid/ask spreads widen and the options are trading at parity. On a $.40 wide bid/ask, if you buy the ask and sell the bid, you are doing the trade for a debit. DON’T EVER DO THIS. If you can’t roll for a credit, just close down the front month option and take your lumps. when you roll for a debit, chances are you will be selling the farther out in time options at a discount and you will be assigned.

  • On 10/09, Mark Borenstein said:

    Your market commentaries have been right on the money in this current bear market.  I wanted to ask your opinion on an open position of mine.  I wrote a ratio put on DIA (Dow ETF) yesterday for Oct Expiration.  I bought 6 OCT 92 puts and sold 12 Oct 87 Puts.  I sold it for a small credit.  I would make money if by next Friday DIA would be above 82.  Now obiously today the market crashed and Dia Is under 86.  Would you suggest taking defensive action (possibly delta neutral)? Being that the premiums are so high would you suggest waiting untill experation and in the event that is below my breakeven legging out my long calls for a profit on those and rolling my short puts down and out to the next month?  Please guide me how you would handle such a trade with this extraordinary volatilty and premiums? Thanks

  • On 10/10, Pete Stolcers said:

    You need to shut the position down. There is no way to measure fear when it reaches historic proportions.

    If you want to leg out, I suggest buying in your short puts on an early rally. Sell your long puts late in the day. The selling has been accelerating into the bell and I believe margin calls are forcing liquidation.

    Your original trade might have worked out, but at this stage you need to make sure you live to fight another day.

  • On 02/22, john ryan said:

    in an iron condor it has hit the short put strike i want to stay in the trade so i roll it down ie a lower strike to finance the trade i sell two otm puts now i am naked if it moves again i do the same thing what is the risk

  • On 02/23, Pete Stolcers said:

    That is know as a Martingale betting strategy. Everytime you lose you double the bet. The idea is that you will eventually win before you run out of money. This is not a trading strategy, it is pure gambling.

    The appraoch has many problems. The first one is that if you started doing this last year, you would be flat broke. As the market contined to decline, you kept doubling your bet. You also failed to admitt when your analysis was wrong. The iron condor was established because you though a trading range would be maintained. When you were proved wrong, you added to the problem by refusing to take the loss.

    Apart from losing all of your money, there is nothing wrong with the strategy.

    Find a trading system that is based on research and analysis and follow it.

  • On 03/11, Jay said:

    Hello Pete,

    I have heard of various kinds of rolling, like roll-up, roll-down,roll-forward, roll-out, roll-up and out??, roll-up and forwaard etc.

    My doubt is;

    1. What does rolling mean and
    2. It would be really nice if you could kindly share the various kinds and names of rolling and their meaning.

    Thanks
    Jay

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