# Options: roll down/up positions



## hissho (6 August 2006)

Hi Wayne and Margaret
Just a couple of questions about rolling down/up positions:
1) When would you roll a position? until the last minute otherwise you could be exercised, or as soon as you think your position could be in danger?

2) when you roll, how do you decide to roll down, roll up to the next month or both? under what circumstances would you just close your position without even trying to roll?

Your reply would be much appreciated,
hissho


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## sails (7 August 2006)

hissho said:
			
		

> Hi Wayne and Margaret
> Just a couple of questions about rolling down/up positions:
> 1) When would you roll a position? until the last minute otherwise you could be exercised, or as soon as you think your position could be in danger?
> 
> ...



Not easy questions to answer but in general:

1) It really depends on how much time to expiry, how much time value is left in the option, whether the stock is about to go ex-div, what strategy you are in, etc.     

2a)  I usually run the comparisons in Hoadley which helps to sort out the best risk to reward. 

2b)   Again, it really depends on what position is on at the time, how far the market has moved from the strikes, what is the T/A outlook for potential recovery, etc. 

Sorry I can't be more specific, but there are just so many variables to consider.

One rule of thumb I do go by when adjusting or rolling - and that is to realise that one is actually closing the current position and opening a new one.  Also need to decide if this new position reflects my outlook for the underlying, eg. would I put it on if I were not adjusting.

Hope this helps!


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## hissho (7 August 2006)

Thanks Margaret!
I knew it's almost impossible to give a detailed answer cos there are too many factors one needs to take into account...
what i intended to ask was some brief comments on the methodology, cos what i learned before was that i should simply wait and calculate how deep my positions are ITM...until the last minute. then i should just roll down or roll to next month(or both) to avoid being exercised.
i very much doubt if this is the right way to manage positions...i kept asking myself "why do i have to wait until the last minute? for example, why not close the positions early and open new positions near the next technical support level? why should i hang on to one stock? why not just close the position and find another stock to put on a trade?"

cheers
hissho


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## wayneL (7 August 2006)

hissho said:
			
		

> Thanks Margaret!
> I knew it's almost impossible to give a detailed answer cos there are too many factors one needs to take into account...
> what i intended to ask was some brief comments on the methodology, cos what i learned before was that i should simply wait and calculate how deep my positions are ITM...until the last minute. then i should just roll down or roll to next month(or both) to avoid being exercised.
> i very much doubt if this is the right way to manage positions...i kept asking myself "why do i have to wait until the last minute? for example, why not close the positions early and open new positions near the next technical support level? why should i hang on to one stock? why not just close the position and find another stock to put on a trade?"
> ...




Hi Hissho,

When extrinsic value is zero, or very close to it, is a good time to roll or close.

Why? Because you've basically captured most or all of the extrinsic value, which was the original goal... and your risk reward has changed. When extrinsic value is close to zero, and expiry is relatively distant, you are exposing yourself to risk for very little (extra) reward.

Hope that makes sense.


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## hissho (7 August 2006)

Thanks Wayne!

Wow i finally heard something different...here's what i was told(take bull put spread for example): if your sold put is ITM, don't worry! just calculate time value and calculate the chance of being exercised. and don't forget the stock can go up again! so most of the time i would start praying and hoping, only to find the stock went south again...

on the other hand, how can i keep myself away from the embarassing situation that as soon as i close/roll my positions, the stock goes up?

cheers
hissho


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## wayneL (7 August 2006)

hissho said:
			
		

> Thanks Wayne!
> 
> Wow i finally heard something different...here's what i was told(take bull put spread for example): if your sold put is ITM, don't worry! just calculate time value and calculate the chance of being exercised. and don't forget the stock can go up again! so most of the time i would start praying and hoping, only to find the stock went south again...
> 
> ...




Ah now we are into specifics... the old OTM bull put spread.

This can be difficult to defend. You can roll down and/or out, but you can also opt to flip as well. i,e. flip it to a bear call. Or you can add the bear call to the bull put and end up with an iron condor This will reduce the downside exposure, but also increase upside, should the bull put comes back into profit. (so long as it does'nt go too far up dammit!)

It must be said that I'm not a fan of OTM credit spreads on stocks (I do use them on indicies). What you have is a _de facto_ covered call with all the difficulties they present. But often they are more highly geared than what is possible with a CC.

When they go wrong, the greeks are unfavourable to easy morphs. You can start flip-flopping with adjustments and butcher a position that may have been otherwise profitable.

I much prefer ATM spreads, Though on the face of it, you have to be more accurate, risk/reward is better, and adjusting is easier.


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## hissho (7 August 2006)

thanks again Wayne

May i ask why "for ATM credit spreads, risk/reward is better, and adjusting is easier"?  

cheers
hissho


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## wayneL (7 August 2006)

hissho said:
			
		

> thanks again Wayne
> 
> May i ask why "for ATM credit spreads, risk/reward is better, and adjusting is easier"?
> 
> ...




OK, have a look at the image below. The red diagram is an OTM  bull put spread (i.e. both options OTM. The blue diagram is an ATM spread (i.e. one option ITM, one option OTM... in other words the current price is between the strikes.)

Note: For the ATM spread, I would prefer to use the bull call version, so-as not to have a short ITM put.

Now the thing to remember is that there are always trade offs. The ATM version has better risk/reward (assuming that the spread was left to expiry and there were no adjustments), that is obvious. But it is at a cost of lower probabilty. The OTM bp spread has a better chance of success, but lower possible profit and higher possible loss.

But when it comes to adjusting...supposing you are thinking to yourself "%$#@ I've got this wrong, the stock is going to tank". With the ATM spread, you can easily morph the diagram to a put backspread with a reasonable ratio, and still have profitability to the upside. To do this with the OTM spread you would have to buy a motza full of puts probably at the expense of any profitability to the upside.

That is just one example. But you can fool around with your payoff diagrams a lot more with ATM spreads. Possibilities are butterflies with embedded diagonals, slingshots (essentially a butterfly with one wing with more long options)

But to my mind the OTM bull put is for when you are *sure* there is strong support above your strikes. At the moment though, I don't think any support is particularly strong.

Cheers


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