How to Rollover Options and Adjust Your Position

Options are financial contracts that grant the buyer the right, but not the obligation, to buy or sell an underlying asset at a specified price, known as the strike price, on or before a particular date. These versatile instruments allow investors to participate in market movements with various strategies, offering flexibility that differs from directly owning shares. “Rolling over” options refers to adjusting an existing options position. This strategic maneuver involves closing an open options contract and simultaneously establishing a new one on the same underlying asset. Traders employ this technique to adapt to evolving market conditions or to manage their existing positions effectively.

Understanding Options Rollovers

An options rollover involves closing an existing options contract and concurrently opening a new one, typically on the same underlying asset. This process usually entails selling to close a long option position or buying to close a short option position, immediately followed by initiating a new contract. The new contract might feature a different expiration date, a revised strike price, or both, depending on the trader’s objectives.
Traders execute rollovers for several reasons, often to extend the timeframe for a trade to become profitable. This adjustment allows more time for the underlying asset’s price to move favorably, potentially preventing an option from expiring worthless. Another common motivation is to adjust the strike price, moving it closer to or further from the current market price of the underlying asset. This action can help manage risk, lock in profits, or mitigate potential losses by repositioning the trade.

Types of Options Rollovers

Options rollovers can be categorized into several types, each serving a specific strategic purpose for traders managing their positions.

Rolling Out

Rolling out involves extending the expiration date of an option to a later month. Traders typically use this strategy when they believe the underlying asset’s price will move in their favor but needs more time to do so. This maneuver allows a trade to continue beyond its original expiry, maintaining a directional view on the asset. For instance, a trader holding a call option nearing expiration might roll it out to a later month if they still anticipate a price increase.

Rolling Up

Rolling up refers to moving an option to a higher strike price for a call option or a lower strike price for a put option, often in conjunction with rolling out the expiration. For call options, rolling up is frequently done when the underlying asset’s price has risen significantly, allowing the trader to take some profits on the original contract and establish a new position with a higher strike. This adjustment can be used to capitalize on a favorable move in the underlying asset or to adjust the risk profile of the position.

Rolling Down

Rolling down involves moving an option to a lower strike price for a call option or a higher strike price for a put option. This strategy is commonly employed to adjust a losing position or to collect additional premium. For example, if a call option is out-of-the-money and unlikely to recover, rolling it down to a lower strike can generate more premium, which helps offset some of the initial cost or potential loss.

Executing an Options Rollover

Executing an options rollover involves precise steps to ensure the current position is closed and the new position is opened effectively. Many brokerage platforms offer a dedicated “roll” order type, which streamlines this process by combining the closing and opening transactions into a single order. This integrated approach minimizes the time lag between trades, which helps reduce market risk.
When using a broker’s specific “roll” order function, traders typically select the existing option contract they wish to adjust. They then specify the parameters for the new contract, including the desired expiration date and strike price. Information such as the quantity of contracts and the order type, such as a limit order to control the execution price, must also be entered.
Alternatively, a rollover can be executed manually by placing two separate orders: one to close the current position and another to open the new one. For instance, if rolling a long call option, a trader would first place a “sell to close” order for the existing contract. Immediately thereafter, a “buy to open” order would be placed for the new call option with the desired strike and expiration. It is important to execute these two orders as simultaneously as possible to mitigate the risk of adverse price movements in the underlying asset between the two transactions.

Tax Implications of Options Rollovers

Options rollovers carry specific tax implications, as each leg of the transaction is considered a separate taxable event by the Internal Revenue Service (IRS). When an existing options contract is closed, any realized gain or loss from that specific contract must be reported. This gain or loss is determined by the difference between the premium received (or paid) for closing the position and the premium paid (or received) when the position was initially opened.
The tax treatment of these gains and losses typically depends on the holding period of the option. Most options contracts are held for relatively short periods, resulting in short-term capital gains or losses. A short-term capital gain or loss arises from assets held for one year or less, and these gains are taxed at an individual’s ordinary income tax rate. In contrast, long-term capital gains, from assets held for over one year, are generally subject to more favorable tax rates, though options are rarely held for such extended durations.
For tax reporting purposes, taxpayers will need to report these transactions on IRS Form 8949, “Sales and Other Dispositions of Capital Assets,” and then summarize the totals on Schedule D (Form 1040), “Capital Gains and Losses.” Brokerage firms generally provide Form 1099-B, “Proceeds From Broker and Barter Exchange Transactions,” which details the sales proceeds and cost basis for these transactions, aiding in accurate tax preparation. Maintaining thorough records of all options trades, including original purchase details and closing transaction information, is important for accurate reporting and compliance.

Important Factors When Rolling Over

Several factors should be considered before executing an options rollover to ensure the strategy aligns with one’s financial goals and market outlook.

Costs

Costs associated with options trading can accumulate quickly during a rollover, as the process involves two distinct transactions. Each leg of the rollover incurs commissions and fees; for instance, many brokerages charge a per-contract fee, often around $0.65 per contract, for both the closing and opening trades. Additionally, the bid-ask spread, which is the difference between the highest price a buyer is willing to pay and the lowest price a seller is willing to accept, can influence the execution price and overall cost of the rollover. A wider spread means a higher implicit cost to the trader.

Liquidity

Liquidity is an important consideration, referring to how easily an option contract can be bought or sold without significantly affecting its price. Options with high trading volume and open interest generally indicate better liquidity, leading to tighter bid-ask spreads and more efficient execution. Trading less liquid options can result in unfavorable execution prices and greater difficulty in entering or exiting positions.

Market Conditions

Market conditions, including volatility and the underlying asset’s price movement, play a substantial role in the success of a rollover. High volatility can lead to wider price swings, potentially making it more challenging to execute a rollover at a desired price. The direction and strength of the underlying asset’s trend should also support the rationale for the rollover. Ultimately, any rollover should align with the trader’s overall investment strategy and current market outlook. This ensures that the adjusted position continues to serve its intended purpose within the broader portfolio.