Dollar Roll

What is a 'Dollar Roll'

A dollar roll is a type of repurchase transaction in the mortgage pass-through securities market in which the buy side trade counterparty of a "to be announced" (TBA) trade agrees to a sell off the same TBA trade in the current month and to a buy back the same trade in a future month.

In a dollar roll, the buy side trade counterparty gets to invest the funds that otherwise would have been required to settle the buy trade in the current month until the agreed upon future buy-back. The sell side trade counterparty benefits by not having to deliver the pass-through securities (which they might otherwise have shorted or committed to another trade) in the current month.

BREAKING DOWN 'Dollar Roll'

The dollar roll transaction is conducted in a market that has the same product and the same coupon rate but with different contract date, hence the term roll. The most common and most liquid contract dates are one-month and three-month rolls. 

The price difference between months is known as the drop. When the drop becomes very large, the dollar roll is said to be "on special". This might happen for several reasons, including large collateralized mortgage obligation deals that increase the demand for mortgage pass-through securities, or unexpected fallout of mortgage closings in a mortgage originator's pipeline. In both cases, financial institutions might have more sell trades in the current month than they are able to deliver securities into, forcing them to "roll" those trades into a future month. The greater the shortage of available securities in the current month, the larger the drop becomes.

Rolls can be purchased by a new transaction where the originator wishes to push their hedge out to a further date. For example, if an investor sells an outright contract and wishes to push it out one month, they would then have to "buy and sell" in the one-month roll market. 

Because there is no increase or decrease in the outright position, dollar rolls carry no, or very little, duration risk. It is simply an extension of a contract, not a new contract.