What is an Index Roll
An index roll is a passive index investing strategy using a combination of index funds and long-term equity anticipation securities (LEAPS). The investor must roll over a series of LEAP options to gain exposure to a long-term move in an index. The leverage from the options allows the investor to magnify gains and can result in outperforming an index over the long run.
BREAKING DOWN Index Roll
Investors can create the same exposure as investing in a standard benchmark through an index roll strategy, but often with less capital because of the exposure from the LEAP option. Over time, the position will have similar payoff characteristics to a regular indexing strategy, but returns tend to be slightly higher because of the exposure from the option in the early stages of the setup.
Buy and hold investors, rather than traders, prefer LEAPS, which have expiration dates ranging from nine months to three years. An investor can replace LEAP call options with call options having later expiration dates, essentially allowing the investor to roll their participation in the asset underlying the option forward indefinitely. LEAP call options can promote greater capital efficiency because they require less capital than buying the asset itself, in this case an equity ETF, employing a strategy with LEAPS called an option roll forward. .
An investor can implement a roll forward using the same strike price for the new one as the old one, or a new strike can be set. A new contracts with a higher strike price than the original option contract makes the strategy a roll up, while a new contract with a lower strike price makes the strategy a roll down.
Volatility determines option prices, with lower volatility leading to lower costs for buying options. While volatility has risen off historically low levels in 2017, it remains below long-term averages making an index roll with LEAPS an attractive strategy.
Limitations of an Index Roll
An index roll strategy employs LEAP call options on a specific equity index ETF such as SPY. However, LEAPS are not available for all ETFs, narrowing the range of asset classes for the strategy. A list of LEAPS options for ETFs can be found online at the Chicago Board Options Exchange.
Investors should consider the cost of rolling options forward before implementing this strategy as rolling requires the investor to close out one option position, potentially at a loss, and purchase a new position.