How to Roll an Option: Key Steps and Strategies

Rolling an option is a technique for managing an existing option position. It involves simultaneously closing one option contract and opening a new one, often with adjusted terms. This process allows investors to adapt their positions to changing market conditions or to extend the duration of a trade.

Understanding Option Rolls

An option roll combines two separate actions: selling to close an existing option and buying to open a new one for the same underlying asset. The key elements that can be modified during a roll are the strike price, the expiration date, or both.

There are three fundamental types of option rolls. “Rolling out” refers to extending the expiration date of an option, moving it further into the future. “Rolling up” involves adjusting to a higher strike price, typically used for call options, especially when the underlying asset’s price has increased. Conversely, “rolling down” means moving to a lower strike price, usually applied to put options, often when the underlying asset’s price has declined. Combinations of these actions are also possible, such as rolling an option out and up, or out and down.

Strategic Motivations for Rolling

Investors choose to roll options for various strategic reasons, allowing them to adapt their positions to evolving market views or to manage risk. One common motivation is to extend time, giving a trade more duration for the underlying asset’s price to move as anticipated or for a market view to materialize. This can be particularly useful when an option is nearing expiration but the investor still believes in the trade’s potential.

Rolling can also be used to take profits, where a profitable existing option is closed and a new one is opened, potentially locking in gains while maintaining exposure to the underlying asset. Conversely, rolling can serve as a strategy for mitigating losses or adjusting positions that are not performing as expected, potentially by moving to a different strike price or expiration date to improve the trade’s outlook.

For short option positions, rolling out or to a different strike can help avoid early assignment, which occurs when the option holder exercises their right before the expiration date. This provides more flexibility and control over the position. Additionally, rolling is a common technique for generating income, particularly for strategies like covered calls or cash-secured puts, by collecting additional premium when rolling to a new expiration or strike price. This allows investors to continue monetizing their positions. Finally, investors may roll an option to adjust the strike price based on a revised outlook for the underlying asset, moving it closer to or further from the current market price to align with new expectations.

Executing an Option Roll

Performing an option roll involves a specific sequence of actions within a brokerage platform. The initial step is identifying the specific option contract to roll and determining the parameters for the new option, including the desired strike price and expiration date. Many online brokerage platforms streamline this process by offering a dedicated “roll” or “roll option” feature. This integrated function combines the necessary closing order for the existing option and the opening order for the new option into a single transaction, simplifying execution.

In situations where a brokerage platform does not offer a dedicated roll function, the process requires placing two separate orders: a “sell to close” order for the existing option and a “buy to open” order for the new option. To ensure these linked transactions execute together and to minimize unwanted market exposure between the two legs, execute them as a “contingent” or “spread” order. This means that the execution of one order is dependent on the execution of the other, allowing for a specified net debit or credit for the entire two-legged transaction.

Common order types used for rolling include limit orders, which allow the investor to specify the maximum net debit they are willing to pay or the minimum net credit they wish to receive for the entire roll. Spread orders are also frequently used, as they are designed to ensure that both legs of the option roll are executed together. After constructing the order, review all details, including the strike prices, expiration dates, and the net debit or credit, before submission.

Financial Considerations of Rolling

Rolling an option has direct financial implications. When an option roll is executed, the transaction will result in either a net credit or a net debit to the trading account. A net credit signifies that the premium received from selling the existing option is greater than the premium paid for the new option, leading to a cash inflow. Conversely, a net debit means the premium paid for the new option exceeds the premium received from closing the old one, resulting in a cash outflow.

Transaction costs, such as commissions and regulatory fees, also play a role in the overall financial impact of rolling options. Many brokerages charge a per-contract fee for options trades. Since a roll involves both a closing and an opening transaction, these fees are typically applied to both legs of the trade. Regulatory fees are also passed on to the investor.

The profit and loss from the original option position are realized when it is closed as part of the roll, converting an unrealized gain or loss into a realized one. From a tax perspective, the closing of the original option leg and the opening of the new one can have implications. The gain or loss on the closed leg is considered a taxable event, potentially subject to capital gains tax.