If you’re trading options in London, you may need to roll over your short positions from time to time. Here’s a look at what you need to know about how and when to do it.
When to roll over
Here are two main reasons why you might need to roll over a short option position:
- The first is if the option is about to expire and you want to keep the position open.
- The second is if the underlying security has moved significantly against your position and you want to try and minimise your losses.
In both cases, rolling over means closing your current position and opening a new one with a later expiry date.
How to roll over
Rolling over a short position is a two-step process. First, you need to close your current position, and it can be done by buying back the same number of contracts you sold initially. For example, if you sold ten contracts, you would need to buy ten contracts to close the position.
The second step is to open a new position with a later expiry date, and it can be done by selling the same number of contracts with a later expiry date. For example, if you sold ten contracts with a May expiry, you could roll over to a June expiry by selling 10 June contracts.
The critical thing is that you effectively close one contract and open another. So, the number of contracts you have open will stay the same.
The cost of rolling over
Rolling over a short option position will usually involve some costs.
First, the standard transaction costs are associated with closing and opening a new position.
Second, there is the cost of ‘carry’. The interest you pay on your borrowed money to finance your original short position. For example, if you sold £10,000 worth of options, you would have borrowed £10,000 to finance the position. If you roll over to a new contract with a later expiry date, you will have to pay interest on that £10,000 for an extra month.
Finally, there is the cost of rolling over the option itself. It is known as the ‘time value’ of the option. The time value is simply the difference between the price of an option with a particular expiry date and the price of an option with a later expiry date.
Why should you roll over?
Rolling over a short option position can be an excellent way to extend the life of your trade and give it more time to work out. It can also be an excellent way to minimise your losses if the underlying security has moved against your position.
Of course, there are costs associated with rolling over, so you need to make sure that the benefits outweigh the costs before making the decision.
When not to roll over
There are also situations when you might not want to roll over a short option position. For example, rolling over might not be worth it if the underlying security has moved significantly in your favour and you’re confident that it will continue. In this case, it might be better to close your position and take your profits.
Another reason not to roll over might be if the option is about to expire and you’re happy to take your chances with the expiry. Finally, rolling over might not be worth it if the costs are too high. Remember, you need to weigh up the benefits and costs before deciding whether or not to pull the trigger.
The risks of rolling over
Rolling over a short option position can be a risky move, so it’s essential to understand the risks before you do it.
The first risk is that the underlying security could move even further against your position, leading to even more significant losses. For example, if you’re short of stock and the price falls from £10 to £9, you might decide to roll over to try and minimise your losses. But if the price then falls to £8, you would have made an even more significant loss by rolling over.
The second risk is that the option’s time value could increase, leading to higher costs. For example, if you roll over from a May expiry to a June expiry, you may have to pay out more money than initially planned.
For those interested in honing your experience, you can sign up for a free trial to test out how to roll over your positions.
