Rolling has grown in popularity, however many misunderstand what it is. I know I did. When I started trading options over a decade ago, I thought rolling what this fantastic trick that allowed me to adjust losing trades into winning trades. So even if I was wrong, I was always going to be able to fix the trade. This is partially true. Partially. For a video walkthrough click here.
Rolling in the simplest sense, is a term that refers to two trades together: a closing trade and subsequent opening trade. Rolling is term that refers to the series of transactions and nothing more. The transactions are still discrete, we're closing a trade and opening a new one. This is the part that threw me for a loop. I thought I could roll a trade indefinitely, however this isn't exactly the case.
Let's breakdown what a roll is and then look at an example. If I sell to open a put and it goes against me, I then choose to roll. By rolling, I am closing that original trade and realizing a loss. I then open a subsequent new trade with it's own risk:reward profile, it's own probabilities, etc. The trades are completely discrete. We call it rolling as a way to tie the trades together, in practicality, they aren't.
Let's look at an example. I opened a fresh test account and as you can see in the top left, there are two different accounts - Net Liq and Cash & Sweep. These different accounts are important to understand. Net liq is what your account is worth if you flatten everything right now. Cash and sweep is how much cash you have available. When we SELL to open, we collected a CREDIT. This credit is placed in our cash and sweep account, however it's TIED to a trade that we have on. This is a $100K account, starting time on 18Nov 21.
T1: In this example, I STO (1) Dec 230P @ 4.3.
Net liq will move as the position PnL fluctuates, in this case, we have an unrealized loss of $0.50 (from the fill). The credit received from opening the trade is deposited into the Cash and sweep.
>Net liq is $99,999.50
>Cash and sweep is $100,430.00
I then fast forward time to 15Dec and here is what the account shows below:
Our Net Liq has dropped to $98,825 (the unrealized PnL of the open trade) and our Cash and sweep has remained the same (no capital has moved in to or out of the account). Let's see what happens when we roll.
T2: BTC (1) 230P @ 16.29
>Realized loss of -$1,175
T3: STO (1) Jan 230P @ 18.96
>Credit received $1,896
Account details below:
Notice, our Net liq has dropped to $98,825. The roll realized a loss and our account value reflects that position. Our Cash and sweep is up even more, now to $10,721.
This is the nature of rolling and this is why we cannot roll indefinitely, even if we are collecting a credit. As soon as your Net liq/account value isn't sufficient to cover the margin requirement, the broker can choose to place you in a margin call requiring you to either neutralize the trade or add capital to the account to cover the cost of the trade. Based on the account and trade sizes, we can roll for an extremely long period of time, I've rolled a position for over a year before and it ended up paying out just fine. However, it's essential to understand we're eroding the value of the account during that timeframe.
Be an Outlier!