Rolling Options: A Polarizing Debate on Probabilities and Winning

I may start an Internet trading war here but I find the idea of “rolling options” to be highly overrated. More specifically, I think the word roll is a crutch many traders, wittingly or wittingly, lean on to mask what’s really happening in their trading account. In my view, not understanding the risk and the probabilities of a trade you enter and exit is a recipe for disaster.

Allow me to explain.

Rolling Options

Say you sold a put for $1.00. Darn it all, the underlying has increased more than you expected it would, and you’re now approaching expiry and the put is trading for $1.50. You want to avoid losing $50. A common tactic in options trading would be to roll your put out to a later expiry, or perhaps down and out to a later expiry and a lower strike price, in order to buy yourself more time on the trade for the underlying to act as you hope it will.

rolling options

Most traders in this scenario will attempt to roll for a credit, hoping to add cash to their account by opening a new position that brings in more credit than is required to pay to close the previous position. Using our example, one might consider rolling the put trade to the next month’s expiration cycle, where the options chain indicates the put is trading for $1.75. The mechanics of the roll would then be to buy to close the current put for $1.50 and sell to open the next month’s put for $1.75, for a net credit on the transaction of $0.25.

Why Rolling Options is Attractive

That seems like a satisfying action to take for many traders. You’ve added more time to your trade, you think, and if you can just make it to expiry, you’ll end up with a $25 profit on one contract, marking a winning trade. Rolling sounds cool, and the net accounting and the buying of time make it seem to many traders like one long trade stretched out until it becomes a winner.

But let’s take a look at what has actually happened here. The roll is the end of one distinct trade, with a profit or loss associated with it, and the beginning of a new trade, with independent probabilities and profit and loss. It actually does not matter that when you roll, the underlying remains the same. It also doesn’t matter to the likelihood of a successful outcome that the “profit” or “loss” you’re using to enter or exit the old or new position is from a similar trade in the immediate past. The new trade either works or doesn’t work on its own.

Walk with me down this path, and I’ll explain everything.

Rolling is Closing One Trade and Opening Another

That’s it. Nothing more. The roll involves selling or buying to close an open position you have, and then selling or buying to open a separate position. The fact that you are able to do so for a net is an accounting concept for you and your broker. The cost to enter the new trade is the same regardless of what you are closing; your broker allowing you to apply the proceeds of a new or old trade to a new or old trade is like exchanging an item at a customer service counter for an item you would prefer instead that happens to be more or less expensive than the original item and then getting back (or paying) the difference as a net amount.

What Rolling Options Does and Doesn’t Do

Rolling does not:

  • magically add time to your original trade, as your original trade is over
  • make a successful outcome more likely
  • inherently change the risk you are taking with the capital involved in your trade

Rolling does:

  • close an existing trade
  • open a new trade

Every Trade Has Independent Probabilities

If you take away anything from my essay here, it should be that every trade you take has its own probability of success. The probability of one trade working out is not dependent on the outcome of another trade. Rolling options has no effect on probabilities.

This is where traders get confused with rolling: they think because they bought themselves more time for a trade to work out with a roll, that it’s more likely to end in their favor. This line of thinking is especially tempting after a long campaign of rolling, where you enter a trade in, say, July, and the underlying has a sharp move against you and continues in that direction. You roll into August, and then the underlying continues moving against you so you roll to September, and then the underlying chops around more but doesn’t recover so you roll again to October. Part of you hopes to never again see the ticker staring you in the face, and it can be enticing to think, damn, I’m due for a win. It’s easy to fall into that psychological trap.

But it is just a trap. The trade you set up in October will either work or not on its own. It doesn’t matter that you have rolled three times. The outcome of the October trade, the trade you entered as a result of the roll, is not affected in any way by the outcomes you experienced in July, August, and September.

A Different View on Rolling Options

Here’s another way to think about it. You’ve been rolling options for a while, and you’re on your third roll, buying to close and selling to open ticker XYZ strike 100 next week. Another trader brand new to options sold to open for the first time ticker XYZ, strike 100, next week. You both got the same credit for your next week short position, and both of you were filled at the same time with XYZ trading at an identical price. Why are the probabilities for both traders different?

Astute readers will conclude correctly that they’re not. Both trades for each trader will behave the same way, reach the same points of probability, have the same probability of touching, have deltas and other greeks move in tandem, and so on. Each trade stands alone, whether you are rolling options or not.

Money is Fungible

Fungible may be a new word to you. It was to me when I first started learning about finances. Oxford’s Dictionary can help us out of this jam.

able to replace or be replaced by another identical item; mutually interchangeable.

Put simply, money is fungible. The capital you use to enter as trade is as green as a paycheck deposited to your bank account, a gift from your brother, or an inheritance. At the end of the day, or week, or month, or year, when you’re flat with no positions on, what you have in your brokerage trading account is cash. What you’re risking is cash. The cash that’s in your account is all the same; no part of the cash is more special, more sacred, more valuable than the other.

Suppose the following: if you lost on a trade in XYZ and try to roll for a net credit on a future XYZ option while hoping that time will bail you out, that’s fine. Let’s look at the cash in your brokerage account to confirm. Assuming your open trade in XYZ you want to roll was sold to open for $1, and let’s also say your brokerage account cash balance was $1,000, your account history will look like this entering your first trade.

Beginning balance: $1,000
SELL TO OPEN -1 XYZ 100 PUT 15 JUL 1.00 (balance $1,100)

But time passes, XYZ nosedives to 90, and you decide to roll out a month.

BUY TO CLOSE 1 XYZ 100 PUT 15 JUL 2.00 (balance $900)
SELL TO OPEN -1 XYZ 100 PUT 15 AUG 2.20 (balance $1,120)

Now let’s assume XYZ closes on August 15 at 101, and accordingly, your put expires worthless. What’s your win? It’s $120, since before you started, you had $1,000, and now you have $1,120.

That should make sense to you. But consider this: you could easily take a new trade involving ticker ABC to recover that loss as well. Again,

Beginning balance: $1,000
SELL TO OPEN -1 XYZ 100 PUT 15 JUL 1.00 (balance $1,100)

XYZ nosedives to 90, but you take your lumps and close it out and enter ABC instead.

BUY TO CLOSE 1 XYZ 100 PUT 15 JUL 2.00 (balance $900)
SELL TO OPEN -1 ABC 100 PUT 15 AUG 2.20 (balance $1,120)

Let’s assume ABC closes on August 15 at 101. Your put again expires worthless. What’s your win? $120, the difference between your starting balance and your current cash balance.

Your account is worth $1,120 at the end of both series of trades. The result of rolling options is no different. The $120 profit is cash in your account. If you were to withdraw it, it spends the same as money from your paycheck, money your parents give you, money you find on a street, money your cell phone company sends to you as a rebate for buying a phone. It’s not special XYZ cash in the first example. The August XYZ credit is not special XYZ credit solely meant to recoup the loss of XYZ premium paid out. And the ABC credit is not special ABC cash that can only be used for ABC trades. It’s all the same money. It’s skrilla. Cheddar. Money. Just cash.

Rolling Options is Not the Only Way to Recoup Losses

You can roll your way out of any mess, the old adage says, as long as you don’t have unlimited capital and the underlying doesn’t go to zero.

While I’m willing to admit the underlying going to zero ought to be a very rare event (unless you’re the Wall Street Bets type that filters only on high IV and tries to rake in premium no matter what), any rule that says you have to have unlimited money is useless as a rule, in my opinion. There are a handful of people in the world with unlimited money; think Bezos, Gates, Buffett. You are not one of them. You cannot rely on this advice when rolling options.

Since money is fungible, since trades have independent probabilities, and since rolling is just opening a new trade and closing a previous trade, you can recoup your losses without rolling. If you do a good job on your technical analysis or your fundamental analysis and pick the best opportunity for your risk capital at any given time, you do not have to enter months-long rolling campaigns to get out of a bad trade. While there is an argument to be made that stocks with a significant fall or rise away from their longer-term moving averages will eventually revert to the mean, that doesn’t mean that the underlying will revert while you are still solvent. Just take your lumps and pick your next battle.

The Last Word

Don’t be fooled by the concept of rolling options. It can be a useful tool, but understand it fully when you use it, and don’t assume it’s doing something that, in reality, it is not.

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