What Is a Roll Back?
A roll back, or roll backwards. refers to a derivatives trading strategy that replaces an existing position with a new one that has a nearer expiration date. Aside from the contract's expiration date, other details are often not changed. For instance, a trader may roll back a September at-the-money call position to a June position with the same strike price.
Traders use this strategy to cut out market risk and volatility in the short or long term. Option roll strategies, sometimes called jelly rolls, can take various forms including roll back, roll forward, roll up, and roll down.
- A roll back involves exiting an existing derivatives position in order to replace it with a similar position but with a closer maturity date.
- A roll back can be employed with either call or put options and is used to increase the long or short gamma exposure in an options position.
- Other roll strategies include roll forward, roll up, and roll down. Roll backs can reduce risk, limit losses, and save on transaction costs.
How a Roll Back Works
A roll back is one of many options trading strategies available to traders and one of many that is labeled as a roll. A roll back may also be called a roll backward. This strategy rolls from one options position to a new one with a more near-term expiration date.
The roll back component of the transaction requires that the expiration month be closer than the previous position. Other aspects of the contract, primarily the strike price, can change or stay the same.
Most roll backs occur as either all puts or all calls. But a trader could potentially switch from one to the other. In all types of roll backs, the option owner sells their options contract in the open market to close the position, then uses the proceeds to roll into the new, shorter-term position.
A roll back is used to increase the long or short gamma exposure in an options position, where an option's gamma is its sensitivity in its delta to changes in the underlying price. A trader would want to increase a long gamma position if they believe the underlying will be quite volatile in the near term, while they would prefer to increase a short gamma position if they believe that the underlying price will remain constant and stable.
Gamma is the rate of change between an option's delta and the underlying asset's price. The option's delta is the rate of change between its price and a $1 change in the underlying asset's price.
Call Roll Back
Traders use a roll back to take advantage of changing market conditions or to revise positions that they no longer see as profitable. Call positions rolled back with higher strike prices are also considered a roll up or a roll back and up. Call positions rolled back with a lower strike price are considered a roll down or a roll back and down. Options with the same strike are just considered a roll back and focus only on the expiration date.
Put Roll Back
A put roll back will roll one put to another with a closer expiration. The trader can use the proceeds from the sale to buy a new put contract with a selling strike price that is higher, lower, or the same as the previous position. Changing the strike price would also incorporate a roll up or roll down. With a put roll back, the investor believes there will be greater profit from the contract in the near term.
Example of a Roll Back
Here are a couple of examples to show how the roll back process works with both a call and a put. Remember, a call gives a trader the right (but not the obligation) to purchase a security by a specific date at a specific price while a put gives the owner the right (but not the obligation) to sell the security by a specific date at a specific price.
Let's say a trader has an October 50 call and wants to execute a roll back. They do so by swapping it out for a September 50 call. This trader may believe that the former October call is no longer worth owning and the September call is a better bet. If the investor is bearish on the stock, they may do a roll back and down with a September 45.
Here's how it works with a put. Let's say this trader purchases the September 50 contract and decides that they'd be better off selling this contract for one with a closer expiration date. They use the proceeds from the sale of the contract to purchase one at the same position for the month of August.
Advantages and Disadvantages of Roll Backs
As mentioned above, options contracts are a hedge against risk and volatility. Traders can take advantage of rolling back on their options contracts in order to reduce market risk, which can put the investor's entire investment in jeopardy.
By cutting back on the risks, roll backs also allow traders to cut down on losses and lock in their profits. That's because this strategy gives them the option to agree on a fixed price for the underlying security with the other party to be purchased or sold by a specified date.
Traders can also save on transaction costs. Trading options contracts, including the execution of roll backs, means the trader puts down a lower cost at the onset of the contract (including commissions) rather than purchasing the underlying security individually. And commissions are generally lower, as traders may have to pay one fee to swap out contracts.
Options trading of any kind requires a lot of experience. You need to have a good understanding of all the risks involved and the potential for losses that may come your way. In short, this kind of trading isn't for novice investors. As such, the firm you work with—the one that handles your accounts—will need to ensure you are experienced enough to execute these trades and strategies, including roll backs.
Speculation plays a big part in options trading. Traders use a variety of techniques to map out which direction their investments will head toward, which means it's never an exact science. You do risk boosting your losses as you try to chase profits if your strategy doesn't work out.
Your brokerage or financial firm may want you to set up a margin account in order for you to trade options contracts. And there may be a minimum balance requirement in order to set this up. This can increase your costs, as it can add interest charges, account fees, not to mention increasing how much you originally intended to invest in the first place.
Reduces market risks and volatility
Limit losses and lock in profits
Save on transaction costs and fees
You need to be experienced in order to take advantage of roll back strategies
Speculation can lead to more losses
You may need to set up a margin account, which could increase your costs
Other Option Roll Strategies
Traders have many strategies available to them when they want to exit or enter options contracts. Roll backs are one of those options. These strategies involve exiting one contract and entering a new one in the same class. While some details of the contract may or may not change, one definite is that the expiration date in the new position is always earlier.
Rolling strategies help option traders to lock in profits, limit losses, and reduce risk. Investors typically roll contracts because the contract they seek to close is far out of the money.
Using the following roll strategies can help an investor to increase their profit potential and capitalize on market changes:
- Option roll up: Traders move from one option contract on an underlying security to another on the same security with a higher price.
- Option roll down: Traders move from one option contract on an underlying security to another on the same security with a lower price.
- Roll forward: A roll forward is the opposite of a roll back. In this trade, a trader moves from one option contract on an underlying security to another on the same security with a longer-term expiration. This is often used by traders who want to extend their position.
Roll Back FAQs
Can You Buy Back an Option You Sold?
Once you sell your option, you generally can't buy it back. But there is a way to eliminate your short position. You can do this by buying a call option with similar details for the same underlying asset, including the strike price and expiry date.
Does Rolling Options Count as a Day Trade?
A day trade is any trade, whether that's buying or selling, that takes place within a single day. Options may count as day trades. But they tend to count as single trades because they are held in one contract.
What Does It Mean to Roll Out of an Option?
Rolling out of an option means that you close and open a position in an options contract at the same time. Roll backs happen when an investor exits a contract with a long-term expiration date and takes a position in one with a shorter-term date.