Rolling Options Definition
Options are short-term securities. The expiration date for most options can range from a few days to a few months. So, investors must make a decision towards the end of the options contract. If you want to keep exposure to the option or take advantage of movement in the stock price, you can roll your option.
There are two types of options for readers who are new to options and those who need a refresher. First is a call option, which gives the buyer the right (but not the obligation) to buy a stock at a given price on or before a given expiration date. Call option buyers believe the stock will go up before the expiration date.
The second is a put option, which gives the buyer the right (but not the obligation) to sell a stock at a given price on or before a given expiration. Put option buyers believe the stock will go down before expiration.
Rolling your options is when you exit your options contract and enter a new similar in its place. The terms of the new options contract may be slightly different than the old one, but it should be on the same stock or other security.
Rolling Options Forward
There are several reasons that traders choose to roll options forward. One reason to roll options before expirations is to avoid a total loss. For instance, if you hold an option where the stock moved in the wrong direction and ignored it, the contract will expire, and you lose the entire premium you paid for the contract.
On the other hand, you can avoid taking a total loss if you exit the contract before it expires. Because the stock didn’t move in the direction you wanted, you’ll probably lose money, but not all of it.
One thing to note about options prices is that they typically swing much more than the underlying stock. Therefore, some traders roll options to lock in gains. For example, if a stock moves in your favor, your options contract moves significantly more in your favor.
In this instance, a trader could be worried that the stock will move back in the other direction. The trader may choose to roll the contract into a similar option with a higher strike price if the stock keeps moving in the right direction. The trader also locked in the gain on the first contract by rolling the option.
Rolling Options Strategy
One thing to know about options contracts is that each contract represents exposure to 100 shares of the underlying security. That means traders can gain exposure to a particular stock or security for a fraction of the price. Since options are short-term securities, maintaining long-term exposures to the underlying security requires a rolling options strategy.
Another rolling options strategy involves covered calls. When investors own a stock, they can sell a call option on that stock. The buyer pays the investor for the call option. If the buyer chooses to call the shares, the seller can lock in a selling price for the stock.
By rolling forward covered calls, the investor can increase the returns on their stock position until the shares are called. If the buyer does not call the shares, the seller pockets the options premium. After that, the investor can continue rolling the option and earning premiums.
Set your strike price appropriately if you’re rolling covered call options and don’t want buyers to call your shares. A call option with a strike price close to the stock’s current price can have a higher premium than a higher strike price. So, it can be tempting to earn a higher premium. If you do that, the risk of a buyer calling your shares is also higher.
Rolling covered call options can also have unintended tax consequences. For instance, investors pay a lower long-term capital gains rate on stocks they hold for more than a year. In some cases, covered calls can halt the time period for long-term capital gains. Consult your tax advisor if you’re considering rolling covered call options.
Selling put options can be risky because investors are exposed to unlimited losses (theoretically, of course). If you’re considering a rolling put options strategy, you could earn premiums if the stock doesn’t increase beyond the strike price. If the stock skyrockets suddenly, you could risk losing a significant amount of money.
Rolling options strategies can benefit traders by increasing income or simulating stock exposure with less money. Options are complicated. In addition, their tax consequences are complex. Make sure you do your homework and know of the risks involved.