Rolling Options Forward – Multi-Month Case Studies in TLT & IWM

This show focuses exclusively on rolling options forward by showing you two different case studies in TLT and IWM. Both trades took multiple months to turn a profit and multiple rolls of our contracts.
Rolling Options Forward – Multi-Month Case Studies in TLT & IWM
Kirk Du Plessis
May 21, 2018

One of the more advanced techniques options traders use to reduce risk and increase the probability of success of the trade is to roll contracts from one month to the next. I'm going to go out on a limb and say that this podcast is potentially one of my favorite ones I've recorded, because I truly believe this concept can help change trades that go against you for the better - and turn losers into winners.

Introduction:

  • When it comes to losing trades, you should rarely lose the full amount. 
  • There is a lot you can do to reduce the risk or turn the trade around by rolling and extending your trading duration. 
  • For example, if 30% of your trades are going to be losers, if you can turn 5% of those around into profitable trades, then that turns the zero-sum game around and flips it on its head. 
  • These strategies and techniques are universal to all industries that you make the trade in -- the concepts work across all different types of sectors and underlyings.
  • Cyclicality goes in both directions. So, if markets go up, sometimes they go back down, and vice versa.
  • If you understand the natural ebb and flow of the market, you will understand why the rolling strategy works well for options sellers. 

CASE STUDY #1: TLT (Bonds)

  • We entered the initial trade in TLT on January 9, 2018.
  • We sold an iron butterfly for $3 - a $3 net credit.
  • We sold the $124 iron butterfly in TLT.
  • The true break-even point was $127 on the call side and $121 on the put side.
  • Ideally, TLT needed to be trading between $121 and $127 by February expiration. 
  • TLT had been range-bound for basically the entire back half of 2017.
  • Almost immediately after we sold the spread, TLT started to move down dramatically as the markets got more volatile in February of 2018. 

February Expiration:

  • As the market started to move down, our position quickly went underwater.
  • We had almost no opportunity to actually close out of the position for a profit.
  • By expiration, TLT had moved all the way down to $118, effectively seeing almost a 2 standard deviation move in TLT. 
  • At expiration, we could have closed the position and banked 100% of the loss, but we decided to take a different approach.
  • We rolled the position from the February expiration contracts out to the March expiration contracts.
  • We closed the February position and re-opened the exact same trade in the March contract, which is called a "rolling trade" — rolling the position from one month to the next month. 

Rolling Contracts:

1. Make sure that you are not paying to extend your time. 

  • If you are going to extend the trade for more time, you need to get compensated for it. 
  • With any adjustment or rolling trade, your first order of business is to reduce risk.
  • Reduce the risk in the trade so that if the trade still goes bad the next month, you lose less money.
  • This means you will always want to take in a net credit when you roll contracts. 
  • In the case of TLT, we rolled the put side out using a vertical roll order.
  • We closed the February contracts and re-opened the March contracts.
  • We closed the February contracts for a debit of 30 cents and sold the March call contracts for a 34 cent credit, which nets out to 4 cents credit.

2. Extend time to see if the position turns around.

  • This allows you to participate if the stock turns around.
  • The extended time could give you the chance to turn a loser into a winner (or simply lose less). 

March Expiration:

  • At March expiration, TLT did not move or rebound.
  • We rolled the contract out again to April.
  • This time IV was a little bit higher, and the put side was rolled out for a 10 cent credit. We sold the $124-129 call spread for 19 cents net credit.
  • The net credit received on the roll from February to March was 29 cents per contract.

April Expiration:

  • TLT had moved up early in the April cycle to $122.
  • We were able to close out of the position completely for a $285 debit, leaving us with a winner on the trade.
  • At the end of the day, we were left with a total credit of $333. 
  • This created a $48 profit for each contract.

CASE STUDY #2: IWM (Major market index)

  • For this case study, the position was first entered on November 15, 2017.
  • We sold a wide iron butterfly and the initial position took in a credit of $629.
  • We sold the $145 calls and the $145 puts and bought the $157 calls and the $133 puts.
  • There was no opportunity to close the trade out for a profit. So, we held the trade until January expiration as the market continued to run higher. 
  • We rolled contracts out to the February expiration cycle.

Roll Trades to Next Expiration Cycle:

  • Since IV was higher in January than it was in November, we were able to roll the contracts for a huge credit to the next month.
  • We rolled all of the strikes out to the next month's expiration (the exact same positions).
  • We rolled the outside legs out for a $109 debit, and the inside legs out for a $143 credit.
  • This created an overall credit on the roll of $34, increasing the total credit in the trade to $663. This additional credit reduced risk on the trade overall.

January Expiration:

  • IWM fell all the way down to $145, which was our exact level needed.
  • We were able to close out of the contracts for a $588 debit.
  • Overall, we made $75 on every contract that we sold.

CASE STUDY #3: OIH (Commodities) 

  • In December of 2017, OIH had a spike in IV. 
  • We sold premium in the January 2018 contracts, selling the $24 call and $24 put (short straddle) for $190 credit. 
  • At expiration in January, OIH had been range-bound in the $23 to $26 range.
  • The market started to move almost immediately against our position, with very little opportunity to close it out at a profit. 
  • By the time we reached January expiration, OIH was trading closer to $29.

January Expiration:

  • We rolled our straddle, using a double diagonal order, for a 3 cent net credit.
  • This is a testament to our back-testing analysis, which gave really clear signals that OIH was either going to stop moving higher or start moving lower at expiration. 
  • The day after January expiration, OIH started a huge downward slide. 
  • OIH fell back down from $30 back down to $24.
  • We were able to close the contracts for a $179 debit.

CONCLUSION: 

  • Ultimately, in options trading, you need to allow yourself an opportunity to win.
  • Sometimes that requires a little bit more patience and a longer trading cycle than you may have wanted. 
  • Some trades just don't go the way we want them to right off the bat.
  • This has nothing to do with the way you set up the position, it's just something that happens. 
  • Instead of throwing in the towel on a losing trade, look at your choices for rolling. Look at your choices for making an adjustment and figure out how you can reduce risk and extend the trading timeline. 
  • Rolling contracts is a great way to achieve this if you keep your position size small.
  • Markets are cyclical, and they will come back around. If they don't, at least you reduced your risk in the process.

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