Discover the Power of Roll Back
A roll back, or roll backward, is a derivatives trading strategy where an existing position is replaced with a new one that has a closer expiration date. Typically, the other contract details remain unchanged. For instance, a trader might roll back a September at-the-money call position to a June position with the same strike price.
Traders utilize this strategy to minimize market risk and reduce volatility over both the short and long terms. Various forms of option roll strategies exist, such as roll forward, roll up, and roll down.
Key Takeaways
- Rolling back involves exiting an existing derivatives position to replace it with a similar position that has a nearer maturity date.
- It can be used with either call or put options to increase long or short gamma exposure.
- Additional roll strategies include roll forward, roll up, and roll down.
Understanding How Roll Backs Work
A roll back strategy transitions from one options position to another with a nearer expiration date. While the expiration date changes, other aspects like the strike price might or might not. Most roll backs involve all-put or all-call options, though it’s possible to switch types within certain contexts.
The process involves selling the current options contract in the open market to close the position, then using the proceeds to enter a new, nearer-term position. This strategy aims to manipulate gamma exposure, where gamma reflects an option’s sensitivity to changes in delta relative to the underlying asset’s price.
Examples of Call and Put Roll Backs
Let’s say a trader holds an October 50 call but wishes to execute a roll back by replacing it with a September 50 call, believing the latter has better prospects. Alternatively, in a bearish scenario, they might replace it with a September 45 call.
For a put roll back, if a trader owns a September 50 put, they might sell it and use the proceeds to purchase an August 50 put, reflecting their anticipation of near-term profits.
Weighing the Pros and Cons
Advantages
- Risk Reduction: Options contracts act as a hedge against market risk and volatility.
- Loss Limitation: Ability to lock in profits while limiting losses by fixing the strike price for purchase/sale by a specified date.
- Cost Efficiency: Lower transaction costs and commissions compared to the outright purchase of underlying securities.
Disadvantages
- High Expertise Required: Not suitable for novice investors due to complexity and potential for significant losses.
- Speculative Nature: High level of speculation can lead to greater losses if the market doesn’t behave as anticipated.
- Marginal Costs: Need for a margin account with possible interest charges and fees, increasing overall investment costs.
Other Roll Strategies to Enhance Your Portfolio
- Option Roll Up: Transition from one options contract on an underlying security to another on the same security with a higher price.
- Option Roll Down: Transition to another option on the same security with a lower price.
- Roll Forward: Unlike a roll back, this involves moving to an option with a longer expiration period.
Roll Back FAQs
Can You Buy Back an Option You Sold?
While you generally can’t buy back a sold option, eliminating this position can be done by purchasing a similar call option.
Does Rolling Options Count as a Day Trade?
Yes, rolling options could count as day trades as both the buying and selling of options often occur within the same trading day.
What Does It Mean to Roll Out of an Option?
Rolling out of an option involves closing a current position and opening a new one simultaneously, often reflecting a strategy to shorten or extend an expiration period depending on the market forecasts.
Related Terms: roll forward, roll up, roll down, call option, put option, gamma, delta.
References
- Schaeffer’s Investment Research. “Rolling Options Out, Up, and Down”.
- Charles Schwab. “Know When to Roll ‘Em: How to Roll Options Positions”.
