Monday, December 28, 2015

The Art of Rolling

In my mind the weakest element of my trading is the calendar. 

Every options trade comes with a death certificate, the expiration date beyond which the position has no further existence.

And every market tool that I've ever encountered, while often strong in forecasting a direction or a trading range, is thoroughly incompetent at anticipating when market turns will happen.

Those facts add an arbitrary quality to options trading. A position moves into a losing posture with a brief counter-trend correction only to expire days before the correction ends and the now-dead options would, in theory, have returned to profitability.

Rolling is the practice of taking profits (or losses) while keeping a position alive on the books. In practice, it exits the position near expiration and enters a new position resembling the old one in some respects.

The effect is to eliminate the capricious calendar from trade.

Rolls have always been an integral part of time-based strategies, such as covered calls, diagonal and calendar spreads: The long leg used to insure a position has a later end date than does the short leg, providing opportunities for a trader to sell the short leg several times, each time reaping a premium.

Rolls are also possible with other trade constructs, such as verticals or even iron condors. However, I'm finding that these tend to be loss-making. I haven't eliminated vertical and iron condor rolls from my tool-kit yet, although I may well do so in the future.

I described a roll as creating a new position "resembling" the one it replaces, a hugely ambiguous word.

An options position has these elements: Stock symbol, strike prices, options series (which determines expiration), options types (calls or puts), and -- in most cases -- the price relationship between the short and long legs (short higher than long or vice versa). How many of these can be changed before the word "resembling" becomes a mockery of all reason?

There's  no question about diagonals and other time spread. When I roll, I set the new strike price of the short leg one or two strikes out of the money and usually move to a later expiration. The long leg remains the same.

Under my present system I have yet to roll forward a long leg. When I do, the expiration will surely change, and probably the strike price as well. Once that happens, all that will remain of the original position are the underlying stock symbol, the options type (calls), and the relative position of the short and long strikes. The strikes and options series will have changed.

It seems reasonable to me to say that positions sharing 60% of their characteristics resemble each other. It is certainly a closer relationship than that of a parent and his or her child, who shares half of the their genes.

The stock symbol, of course, must remain constant across a roll.

I can't envision a resemblance of options positions that entailed a change in the options types and their positions relative to each other.

For example, a diagonal by definition is composed of call options that are arranged like this: The short leg has a higher strike price than does the long leg. 

Reversing the two would change the structure of the trade into something other than a diagonal spread. Indeed, it would cease to be a time spread since the long leg, through the theta property of the options, would decay more rapidly than the short leg.

Likewise, changing one of the legs from calls to puts would alter the position into something other than a diagonal by eliminating the role of the long leg as placing a limit on the potential loss. It might be a possible tactic, but I see no practical use for it.

So I suspect that my rule for rolling will end up requiring stability across positions for the stock symbol, options type and relative strike position. Everything else likely will be available for adjustment in order to achieve the most advantages trade.

The way I report rolls on Private Trader has proven to be something of a mess. My practice of posting a short update on the trade page with the outcome of trades has proven sufficiently terse and informative, but when a position consists of roll after roll, I end up with a stream of the identical notes that make little sense even to me.

I'm changing that. I shall post an update noting the most recent roll and follow it with a table of all rolls. I've done that with UNG, perhaps the most prolific of rolls among my diagonals, making the edit today. Click here to see it.

I shall make similar edits for other 10 rolled positions as they are rolled or exited entirely.

-- Tim Bovee, Portland, Oregon, Dec. 28, 2015

Tradecraft: Playing the odds to build winning stock market trades from options, a description of how I trade, can be read here.


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Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.
No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decisions for his or her own account, and take responsibility for the consequences.

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