Rolling an Options Trade Explained | Options Trading Concepts

hello everyone and welcome back to Mike and his whiteboard my name is Mike this is my whiteboard and today we're gonna talk about rolling so if you're brand new to this segment this is a segment where we construct concepts in a visual way so rolling is actually one of the more popular topics in support specifically we get a lot of questions about rolling what it means what it gives you what you can do with it so today we're gonna break down the rolling strategy and one thing I want to point out is that rolling is basically when you're closing your old trade and you're opening a new one at the same time so this is gonna be done for either a net debit or a net credit or for it even so we at tastytrade like to do this for even or a net credit because that's when the benefits come into play so let's start on the first slide here and we're gonna look at rolling a naked put so we're going to be looking at a 45 put in September with the stock trading at 50 so we're these are all the numbers are all arbitrary here but you'll see the bigger picture when we get to it so we're gonna sell the 45 put for $1 so the probability of profit on this trade we have marked as 60% so this is over 50% because we're out of the money we're selling it out of the money put so if we review from other whiteboard segments and out of the money put is basically selling a put below the stock price because a put gives the owner of the put the right to sell 100 shares at a certain strike so if I'm if I'm selling that that right to someone then that gives them the right to sell their shares at 45 and right now the stocks trading at 50 so the put has no value or no intrinsic value right now so it's considered out of the money now if I'm selling a put for 45 for $1 that means that my max loss is going to be 44 hundred dollars and that's because instead of selling the stock at 45 so if I'm selling the right for someone to sell me the stock at 45 if the stock price goes to zero I'll have to buy back this put for $45 but since I received $1 and credit for that that brings my break even lower than 45 to 44 so let's move this along and see what happens when the stock price moves down so we sold the September put originally for a dollar now the stock price is trading at 40 so let's say we're right around September expiration and we have intrinsic value so intrinsic value is essentially this difference between the stock price and the strike price so if I sold to put at 45 and the stock price is now 40 that put has to be trading for around $5 at expiration I've got it for over five dollars five dollars and five cents because you'll always see a little bit of extrinsic value up until expiration so we sold the put if we sold the September 45-foot for one dollar now we have to buy it back for 505 or what we can do is roll the trade into the future so here we're closing the September put for 505 and we're opening the October naked put for 575 so what this does is gives us a net credit and it reduces our max loss so if we look at the the analytics of this particular trade we're gonna have our max loss reduced and a net credit shown of 70 cents here so what this does is allows us to go further out in time and I'll let us collect a net credit so in a sense we're giving us more time to be right or keeping the dream alive as you might hear on tastytrade and that's one thing that we're gonna want to do so you'll see that the probability of profit here is lower than 60% so that's another thing that we want to take into account yes we're keeping the dream alive and we're receiving an additional credit for this trade in particular but our probability of profit is now much lower because we're selling an in the money put for October the stock price is now at 40 so for this to be profitable the stock price has to move where as originally when we sold the the 45-foot when the stock was trading at 50 we could have been profitable if the stock price didn't move it all moved up or move down a little bit so that's one thing to keep in mind when rolling is that once you roll defensively you have to be directionally right so again 35% pop these are arbitrary numbers but you get the picture that now it's a lower probability trade our max loss has gone from forty four hundred to forty three thirty and that's because we're collecting an additional credit so again we're buying back the September put for 505 and selling out the October foot four five seventy five so let's discuss why we can do this so if I'm buying back the 505 put four there the September put for 505 and I can sell the October put for five seventy five the reason I can do this is because there's extrinsic value assigned with more days to expiration just like when we were talking about an earlier whiteboard about expert or extrinsic value when we push the option out in time that option is going to have more extrinsic value which increases the option price so since we can do this for a net credit of 70 cents this is a good trade my my directional assumption is the same so I still am bullish on the underlying but I want to give myself more time to be right so I decide to roll the trade instead of close it so we've got a net credit of 70 cents our max loss is lower but our pop is lower as well so let's tie this all together and see what it all looks like on the next slide here also we've got to realize loss of 405 so this is really important to take into account so although we're giving ourselves more time to be right with this 70 cent credit we have locked in a loss of 405 so originally if we go back thinking back to the original side we've got the put that we sold for $1 so if I sell a put for $1 for me to close that position I have to buy it back so if I'm flat and then I sell an option I have to buy it back to close it or if I'm flat and I buy an option I have to sell it back to close it so since I sold it for $1 and now I have to buy it back for 505 that's a realized loss of 405 it's just the difference between the two sold it for a dollar buying it back for 505 the difference between that is 405 so let's throw it all together on the next slide here our old breakeven price was $44 and you can see that with the green arrow here it's less than 45 because we received that $1 credit our new breakeven with the roll is going to be 40 330 and it's lower than our original breakeven because we're collecting an additional credit now we have a new trade that's going to have a lot of intrinsic value because we're selling it for 575 so it's got five dollars worth of intrinsic value right now and 75 cents worth of extrinsic value but since we're adding more time we can collect this for a net credit so our old breakeven is now worse than our new breakeven so that's great for us but our probability is lower so that's just the big idea with rolling is that although if you have the the same assumption you have to realize that you're opening a new a new trade that's got a lower probability of profit so how can we reach our break-even price so we collected a dollar originally and we collected an additional 70 cents net net so now what we have is a collection of a dollar 70 for me to break-even I would need to close this position for a dollar 70 because basically if I collect a dollar 70 and then I buy back the position for dollar 70 that means that I've broken even so you can click it's all basically a simple math equation so if I take the realized lost of 405 and subtract a dollar 70 you'll see that that's the the difference here so what you need to keep in mind is that whatever credit you received for you to break even on that trade you need to buy back that position for that same amount so that would bring you to a flat position so let's get to our takeaways with rolling here so number one rolling is the result of closing your old position and opening a new one at the same time so again you're not giving yourself free time or free expiration days for nothing you're closing a position especially rolling defensively you're closing that position for a loss and you're opening a new position with the lower probability of profit but if you can do it for a credit you're going to reduce your breakeven price which is what we're all about with cost basis reduction again we keep the dream alive one rolling so if I close a position in September and I open a new one in October I now have a whole nother month for me to be directionally right and correct on the trade and I can even reduce my break-even point which is going to help me out all in all in the trade so rolling can reduce cost bases further so again like you saw here we open the trade for a dollar and then we rolled the trade for an additional 70 cents which since we're collecting more premium is going to reduce my max loss and reduce my break-even point when rolling defensively the pop of the new trade will be lower so this is a crucial concept to keep in mind is because no matter even if we roll into perpetuity regardless of how deep in the money it goes we might be able to continue to get credits for naked option positions you'll see it's going to be much harder for debit spreads or credit spreads or anything else any type of spread it's going to be much harder to get that credit or roll for even than compared to naked options but when you roll that trade with a naked option you just need to keep in mind that the further in the money it goes it's going to be a lower and lower probability of profit so for me personally I need to consider when I'm making that trade whether I still want to keep that on or if I can take the trade off and use that capital more efficiently elsewhere and last but not least rolling defensively results in locked in losses but keeping the trade open gives you a chance to offset that so in this example we showed a realized loss of 405 but we opened the new trade for 575 so if that trade goes all the way out of the money so if the stock price goes from 42 above 45 I've now completely wiped out that realized loss that I had and I also get to keep that dollar 70 in credit that I received for all those rolls that I did so this has been rolling if you've got any other questions about rolling shoot it over to support at tastytrade.com or support at doe comm or you can tweet us at doe trading at doe trader Mike or at tastytrade tomorrow we're going to get into a little bit of strategy so we're going to talk about covered we're gonna break it down completely and we're going to discuss why we do this and what benefits we can receive from placing a covered call as opposed to just buying stock outright so thanks for tuning in my name is Mike and this has been Mike and his whiteboard hi everybody I hope you like this video click below to watch more videos subscribe to our Channel and don't forget to watch us live at tastytrade com

Channel: tastytrade

Views: 87,627

Rating: 4.7486911 out of 5

Keywords: rolling a trade, options trading, how to trade, investing, finance, rolling options, how to trade options, options, learn to trade, closing old position, bullish strategy, tastytrade

Id: VqsFQNOocB4

Length: 11min 39sec (699 seconds)

Published: Tue Feb 02 2016