Rolling contracts
When an investor establishes an options contract through an opening transaction, there is no obligation to maintain the position until it expires or is exercised. In fact, most options contracts are “liquidated” (closed out) through closing transactions. Instead of ending a position indefinitely, some investors choose to “roll” their contracts. There are three general ways to do this:
- Roll up
- Roll down
- Roll out (forward)
Rolling up
Rolling up an option involves replacing a contract with another containing a higher strike price. Let’s assume an investor establishes the following covered call position:
Long 100 ABC shares at $54
Short 1 ABC Jan 55 call at $4
If the investor believed ABC’s stock price was poised to rise soon, they could “roll up” the option position. The short call will be assigned if ABC’s market price rises above $55. The investor likely wants to avoid being assigned, as it would require a sale of ABC stock at $55. Most covered call investors hope the short call expires and the stock price doesn’t rise significantly (otherwise, they face opportunity cost/risk).
To “roll up,” the investor would liquidate the short call through a closing purchase (assume a $3 premium) and establish a new short call with a higher strike price through an initial sale:
Short 1 ABC Jan 55 call at $4 (initial premium received)
Long 1 ABC Jan 55 call at $3 (premium paid to close)
At this point, the investor’s short call position is closed. They initially received a $4 premium when establishing the position, then paid a $3 premium to close it out, resulting in a net $1 credit ($100 overall gain). Now, the investor only has one remaining position:
Long 100 ABC shares at $54
Now, the investor can sell a new call with a higher strike price against the stock position. Let’s assume a new Jan 60 call is sold at a $2 premium:
Long 100 ABC shares at $54
Short 1 ABC Jan 60 call at $2
To summarize, the investor began with this position:
Long 100 ABC shares at $54
Short 1 ABC Jan 55 call at $4 (closed for a $3 premium)
And ended with:
Long 100 ABC shares at $54
Short 1 ABC Jan 60 call at $2
Therefore, “rolling up” involves closing a contract and replacing it with a new contract containing a higher strike price.
Rolling down
Rolling down an option involves replacing a contract with another containing a lower strike price. Let’s assume an investor establishes the following covered call position:
Long 100 ABC shares at $54
Short 1 ABC Jan 55 call at $4
If ABC’s stock price fell (assume to $48), they could “roll down” the option position and collect more in premiums to offset their stock losses. Although the stock decline is favorable for the option contract, the investor’s stock position loses more value the further the market price declines. Closing the contract and replacing it with a lower-strike price call would allow the investor to make more money off premiums.
To “roll down,” the investor would liquidate the short call through a closing purchase (assume a $1 premium) and establish a new short call with a lower strike price through an initial sale:
Short 1 ABC Jan 55 call at $4 (initial premium received)
Long 1 ABC Jan 55 call at $1 (premium paid to close)
At this point, the investor’s short call position is closed. They initially received a $4 premium when establishing the position, then paid a $1 premium to close it out, resulting in a net $3 credit ($300 overall gain). Now, the investor only has one remaining position:
Long 100 ABC shares at $54 (currently worth $48/share)
Now, the investor can sell a new call with a lower strike price against the stock position. Let’s assume a new Jan 50 call is sold at a $3 premium:
Long 100 ABC shares at $54
Short 1 ABC Jan 50 call at $3
To summarize, the investor began with this position:
Long 100 ABC shares at $54
Short 1 ABC Jan 55 call at $4 (closed for a $1 premium)
And ended with:
Long 100 ABC shares at $54
Short 1 ABC Jan 50 call at $3
Therefore, “rolling down” involves closing a contract and replacing it with a new contract containing a lower strike price.
Rolling out (forward)
Rolling out (forward) an option involves replacing a contract with another containing a longer expiration. Let’s assume an investor establishes the following covered call position:
Long 100 ABC shares at $54
Short 1 ABC Jan 55 call at $4
If the short call was going to expire within a few weeks and ABC’s market price remained flat, they could “roll out” the option position and collect more in premiums. As the Jan call approaches expiration, its time value declines rapidly, allowing the option to be closed for a lower premium. Selling a new call with a longer expiration results in a new premium received.
To “roll out,” the investor would liquidate the short call through a closing purchase (assume a $1 premium) and establish a new short call with a longer expiration through an initial sale:
Short 1 ABC Jan 55 call at $4 (initial premium received)
Long 1 ABC Jan 55 call at $1 (premium paid to close)
At this point, the investor’s short call position is closed. They initially received a $4 premium when establishing the position, then paid a $1 premium to close it out, resulting in a net $3 credit ($300 overall gain). Now, the investor only has one remaining position:
Long 100 ABC shares at $54 (currently worth $48/share)
Now, the investor can sell a new call with a longer expiration against the stock position. Let’s assume a new Jun 55 call is sold at a $6 premium:
Long 100 ABC shares at $54
Short 1 ABC Jun 55 call at $6
To summarize, the investor began with this position:
Long 100 ABC shares at $54
Short 1 ABC Jan 55 call at $4 (closed for a $1 premium)
And ended with:
Long 100 ABC shares at $54
Short 1 ABC Jun 55 call at $6
Therefore, “rolling out” involves closing a contract and replacing it with a new contract containing a longer expiration.
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