Lesson Overview

Rolling Options Trades for Duration & Premium

Rolling options trades for duration and premium is one of the ways we can extend our trading timeline and give ourselves enough time for the markets to turn around in our direction. It's important to comment that we always total profits after all rolls or adjustments vs on an individual trade basis.

Show Video Transcript +

In this video, I want to talk about rolling trades for the duration and additional premium.

First, what is rolling, right? I mean, hopefully, you've gone this far in our track. You know what it is, but if you haven't, or if you're just starting out with this video, or found us online, rolling, or when it comes to options trading, is simply the process of moving a trade from one expiration date to another.

For example, you would roll the contracts from June to July, or from July to August, or whatever the case is. Now, specifically, you would close the first month, and then re-open the next contract month.

That is the particulars on how you roll the contracts. We'll go through some examples here so you can see it as we're going through this video tutorial, but most people don't understand that you can do this in one trade or you can split up and do it in two trades.

There's many different ways to do it, but again, you're closing out of that front month, or that first month, and then re-opening the trade in the next month out.

Now, it's also important to comment at this point that we don't consider rolling trades on an individual basis for performance because, in our view, it's still the same position. We'll always total overall P&L at the end of the trade post-adjustments.

What a lot of people end up doing, and we usually get a lot of comments like this is, "But Kirk, you don't understand that you close the first position for a loss, or that you roll the first position for a loss." We get that.

We're not saying that we didn't or that we did. We just wanted to point out that when we total our P&L, we total it after any adjustments are made to the trade. If at the end of the day, we end up losing on a trade, we'll total up our post-adjustments and losses.

Just to prove the point here, and kind of look at what rolling a contract would look like ... Let's say for example that you sold the 50 calls for June for $2 at some point. Later on, the stock moved against you, so the stock moved higher.

You bought back your 50 Calls for $250, so in the June contract month, you did lose $50. This is the way that most people think about it, but our way's a little bit different. You did lose $50. We're not disputing that. That's definitely what happened.

Let's say that you rolled out to July, so immediately you closed out of June by buying back your 50 calls and you re-sold the 50 calls in July for $3. Then, later on in the July expiration month, let's say that the stock moved down and moved favorably.

You bought back your 50 calls for $1.50 now, and in July you took in a profit of 150. Now, the net difference between June and July is you're still taking in a profit of a dollar at the end of the day.

It's still the same position that you carried from one month to another, so whether you look at it on an individual basis or a total basis, it's all the same numbers. It doesn't change; it's just kind of like how you total it up.

In our case, what we would look at is, we would say okay look, you roll the contract, so you opened the original position for $2, you bought it back for $2.50, you rolled the contracts out to the next month and sold the July 50 calls for $3.

Eventually you end up closing out of the entire position at $1.50, so your net profit after all adjustments is $1. At the end of the day, again, you get back to the same number. You can't hide from the numbers.

Whether you total it up at the end, or you take the individual basis, we just prefer, just for simplicity, just to take the end basis for everything that we're doing, so that makes it easy for tracking.

Again, we'll go over an example here so you can kind of see historically what we've done, but first let's answer the question, "Why do we want to roll trades?" Well, the number one reason that we want to roll a trade is to increase our premium, and therefore reduce risk in a trade.

That's something that we've talked about previously here on track number three, is that rolling to the next month is great, but if we can't increase our premium or reduce risk, meaning take credit that widens out our break-even points, then it doesn't make sense.

We're never going to roll for a riskier trade. We're never going to extend the trading timeline for a riskier trade. The first thing is, we always want to increase our premium, which is going to reduce risk.

Number two is that it extends our duration or our trading timeline. See by rolling the trade from say June to July, what we end up doing is extending the trade another 30 days, or if we roll it again, we end up extending the trade another 30 days.

It gives us enough time to see maybe the stock come back into our range. Now, number two kind of fits right on top of number one in that sense that, if the trade never ends up working out, and this is why number two is behind number one...

If the trade never ends up working out ... Let's say we roll the trade to the next month and then we roll it to the next month again and again, and the trade still never ends up working out, as long as we did number one every time that we rolled, meaning every time we adjusted or roll the contracts we increased our premium and reduce risk, then so what if the trade never works out?

If we gave ourselves enough time, we gave ourselves a shot at being right, so what if the trade never works out? At least we reduced risk the entire way that we were moving the trade. Again, we'll show you an example here of that in this video. Number three is that it maintains our exposure for "on-the-fence" positions in the next expiration month.

This is really why we put this towards the end of track three, kind of in this whole expiration section about what to do with trades as we get closer to expiration is that anything that's "on-the-fence," so something that could be potentially profitable or could be a potential loss, anything that's trading right around your break even point.

If you can extend the trade out for another month, it just gives you a little bit more confidence to know that you've got more time to manage the position, instead of being forced into a decision the week of expiration that you might not want to be forced in to.

Let's look at a very specific case study here of SMH. Now, this is a live public trade that we did, so all of the history on this is on our website.

There's video tutorials for every single one of these entries and adjustments that we had again. I'll post it live, but we're going to review it here because I think it proves a point of what we're looking to do for rolling trades to the next month.

Okay, not necessarily adjusting them, but rolling contracts from month to month. The original trade that we had here in SMH was a call credit spread that we entered on January 20th. We sold the 57/58 call credit spread.

At that point, we took in a credit of $27, and since it's a $1 wide spread, that means our max risk for each of the contracts that we traded was $73. Again, if we go here and look in our account statement ... This is my statement here on Think or Swim going back to the date that we have.

Again, this is all real stuff, not paper money. This would be a different symbol if it were paper money. You can see here that our original trade was right here back on 1/20, where we had sold the SMH 57/58 call credit spread for a $27 credit. Okay, so that was the original trade.

If we go back to the charts here, you can see that 1/20 was this day right here, okay? This day right here was 1/20. This is SMH back in 2015. Now, we have sold the 57/58 call credit spread, which means that 57 is abour right there.

That was kind of our line in the sand. That was our short strike on the call side was right at 57. Ideally, by the time that March expiration came around because this is March expiration, this dotted line right here, by the time the March expiration came around, we want the stock to be below this price point.

Well, you can naturally see what happens. At the time that we entered this trade, the stock was trading well below the 57 strike, and let me just draw that line in the sand again, but as we went closer to February expiration, and then we got into the March cycle, you can see the stock started trading above our break-even point.

Okay, dipped quickly in the middle of the month, but then again, as we went closer to March expiration, basically the day before March expiration, the stock was on the money. We were looking at, potentially, a full loser if we did nothing at all to manage this trade.

Okay, so we're at March expiration, which is the last day right here. The stock is a full loser because it's above our break-even point. It's trading around 58. It's almost close to our long strike.

What we ended up doing is we ended up rolling the contract or the spread from March to April. We took this same exact position, the same 57/58 call spread, we closed out of the March position, and we re-opened the April position.

The difference, or the net credit in doing that, between buying back one side and reselling the other, was a $10 credit. Again, this is our key here that we always talk about is we have to take in a credit to roll this trade to the next month. We took in credit.

That means our new total credit on the trade, after the initial credit that we took in, is $37, and again, our new max risk, because we didn't increase the width of the spread, we did the same number of contracts, so we have the same risk profile being a dollar wide spread, but now we have a bigger credit, so our new risk gets reduced down to $63.

More importantly, we get a little bit more time for this thing to work out in our favor. Again, if I go back to my account statement here, you can see we did the vertical roll. We did this all in one order, okay?

We closed out of the March contract, so you can see we're closing here, the 57 calls, the 58 calls, and then we're re-opening the same strike prices in April. Okay, so notice we're not changing our strike prices, all we're doing is extending the trading timeline from March to April.

You can see all the different prices are here, of what we closed and bought back, and then the net result is that we added a $10 credit to this trade. Now we're looking at a $37 credit for each of these contracts.

Again, if we go to the charts here, all we're trying to do is just give ourselves more time, right? The stock had a huge rally right before expiration, so we're just betting. Look, if we can increase our credit in this trade and extend our trading timeline out another month, maybe the stock falls back down below our break-even point.

Now, the question most people have is, "Well what if the stock never did? What if the stock never fell below that break-even point?" This is where I say, as I said at the beginning of the video, is that I don't care if the stock never falls below that break-even point.

At least I gave myself a shot, so if the stock just rallied higher and never turned around, so be it. At least I gave myself a shot, and more importantly, I reduced my risk from $73 down to $63 on this trade. It wasn't a lot, but it was a reduction of risk, and we gave ourselves a shot to be right on this trade.

Now you can see what happened. Three days after expiration, the stock had a huge reversal in turn around and traded all the way down to $54, so when that ended up happening, a couple of days later we closed out the entire position and bought it back for a net debit of $15.

Again, after the roll, post-roll, we ended up making about $22 on each of these contracts that we sold for SMH. Again, I'll go here to our position statement, and you can see, just a couple days later on 3/25, we went ahead and closed out of the contracts that we had at 57 and 58 for April and made a nice little profit on the trade.

Okay, so again it's not that this thing was a huge winner, but it proves the concept that we're looking, is that we could have been faced with a loser, actually probably a pretty big loser had we done nothing at all coming into March expiration, but the key here is that we were able to extend the trading timeline and we did it for a credit.

That's the most important thing, are we did it for a credit that reduced risk first, so that we could roll the trade out and give ourselves a little bit more time. Now, look. I could be here all day and night showing you a gazillion different examples of why extending duration works and how all of these different things might happen.

Of course, I could show you examples where it didn't work, so I'm not going to dispute the fact that sometimes you could roll and sometimes the stock just keeps going higher or keeps going lower.

Like I said a million times in this video, the key is to make sure that if you roll, you're taking in a net credit to do so and reducing risk. Even if the trade still goes against you, at least you cut the loss. This goes for every type of short premium strategy.

It's your credit spreads, your iron condors, your iron butterflies, strangles, straddles, everything. If you can't take in a net credit to roll that trade out to the next month, it's not worth it. Just take the loss and reset your strike prices in the next contract month, reset the table.

Take your loss, bank it, and move on. Don't just put yourself into a bigger hole by paying to roll out to the next contract. You never want to do that. Some rolling considerations.

Things you should think about as you're considering whether you want to roll a stock trade or not, and that is done you have the same underlying assumption on the stock. Meaning, are you still generally bearish, bullish, or neutral.

What is your assumption on the stock? If we go back to SMH, right before expiration, the stock just had a quick rally higher. We had seen the stock make a huge rally higher and then fall from that high.

Heading into that expiration day, where we had to make our decision of whether or not to roll, we still had a bearish bias on the stock. We still thought that every time that this thing rallied that it would be followed by some selloff or some profit taking on the stock level.

We still had that bearish assumption, which is part of the reason why we rolled. We were able to reduce the credit, which was obviously great. We had that still underlying stock assumption.

Another question you should ask yourself is, portfolio fit "post-roll." If you were to roll the position to next month, and if you then looked at your data weighted portfolio with this new roll in it for next month, does it dramatically affect the tilt, or the neutrality of your portfolio?

Again, this is just a question you should start asking yourselves more and more as a professional trader is, "How does this position fit into my overall portfolio next month. Does it make me more unbalanced?

Does it make me more balanced?" Maybe rolling this contract, even though you might take in maybe a $5 credit, gives you a lot of balance in the next month with all of the other positions. Maybe it's worth doing for that. The last question you should ask yourself is, "Do I have a better use of my capital elsewhere?"

If you're tying up a lot of capital with this trade, is there some place else that you could maybe make the same amount of money that you could make on this trade by having a higher probability of success or entering a better trade with better liquidity, or just basically use your capital in some other trade in a better capacity?

In most cases, the way that we trade here because we've outlined it in track number three, we usually have the capacity and the capital to hold on to some of these trades for a couple of months if they don't go our way immediately.

But if you don't have that capacity and that capital behind you, you might want to start asking yourself, look, you know, "There is another trade out there where I can make $37, in this case with SMH, and have a higher probability of success than trying to hope that this thing comes around?" Right? That might be a consideration and a question that you ask yourself before rolling.

Hopefully this video's been helpful for you. Thank you so much for checking it out. If you have any comments or feedback, I'd love to hear them in the comments section below.

If you loved this video, thought it was helpful and understanding how to roll options and what you should be thinking about as you're rolling contracts from one month to the next, please share it online. Help spread the word about what we're trying to do here at Option Alpha. Until next time, happy trading.

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