What is a Roll Down?
A roll down is an adjustment strategy in options trading. This strategy allows an option trader to improve the opportunities for profit by lowering the strike price to a more favorable position.
This is accomplished by closing the initial contract and opening a new contract for the same underlying asset at a lower strike price. A roll down accomplishes this action as a single trade, and therefore requires only a single commission charge.
- This strategy allows traders to change an option contract to a lower strike price.
- Traders execute a spread order to efficiently close one contract and open another at a lower strike.
- This action is usually performed in conjunction with an expectation of continued falling prices.
How a Roll Down Works
Option traders may find that they can make more money by holding their position at a lower strike price. It is simple enough to close their former trade and reopen the same position on a lower strike price, rolling the option down is a technique that is slightly more efficient. To roll the option down, a trader must put in an order that closes their current position and opens the same kind of position but with a lower strike price. This can be done simply by opening a trade for an option spread that accomplishes what might be needed.
For example, suppose an investor owned 100 shares of a stock priced near $200. The investor wants to hold the shares as long as possible, but wants to make some income from holding on to the shares also. The investor sells a covered call and opens the option trade with a strike price of $210 with a month before expiration. Two weeks later, the price of the stock is now down below $195. The investor realizes that they can make more profit if they were able to switch from a $210 strike price, down to a $200 strike price.
In this scenario the investor could either close the $210 covered call position (buy it back at a lower price), and then sell another covered call at $200, or they could simply open a short call vertical spread trade (also known as a bear call spread) that includes the $210 and $200 strike prices. The action of initiating this trade breaks down this way:
- It purchases a contract at the $210 strike price.
- It sells a contract at the $200 strike price.
- Since the initial position was open by selling a contract at the $210 strike price, then this action now closes that position, leaving the new contract at the $200 strike price to be the only remaining contract open.
- Thus, the position is effectively rolled down from 210 to 200 in a single trade.
Other Types of Rolls
Roll downs can happen as part of any option strategy where the trader wants to benefit from a lower strike price. A roll down can happen with calls, puts or existing spread trades. A roll down, whether on a call option or a put option, is usually a bearish strategy, benefiting from prices falling further, where a roll down could be a bearish strategy.
When rolling calls, the new position will be more expensive than the old position, due to the lower strike. New put contracts will cost less in a roll down than the old put contracts. Depending on whether the old and new positions are long or short, the result of a roll up could be a debit or a credit to the account. How much depends on the price differential of the rolled options.
There are several reasons why a trader would roll down a position. They include avoiding exercise on short put positions. Or, it simply could be an expression of increased bearishness for a long put position and wanting to roll the contract to a later expiration date. Remember that an in-the-money long put loses most of its time value, so rolling to an out-of-the money put would give the trader partial profits and possibly more bang for the buck, thanks to the lower price of the new puts.
A long call position might roll to a lower strike price if the underlying asset moved lower in price but the trader still believes it will eventually rise. In this way, the position remains in place with losses cut somewhat.
If the new contract involves a higher strike price and a later expiration date, the strategy is called a "roll-up and forward." If the new contract is one with a lower strike price and later expiration date, it is called a "roll-down and forward."
Options traders use rolling strategies to respond to changing market conditions and to secure profits, limit losses, and manage risk.