Options are traded on the Chicago Board Options Exchange. They are known as derivatives because they derive their value from other assets, such as stocks. The option rollover strategy involves exchanging two or more option contracts with different characteristics.
There are two types of options: calls and puts. An option is a contract that gives a buyer the right, but not the obligation, to buy (call option) or sell (put option) the underlying stock at a “strike price” on or before the “expiry date.” The “premium” is the trading price of the contract. Each contract “multiplier” is 100. Therefore, if the premium is $1, the investor pays $100 to buy one contract.
Rollover strategies usually involve exchanging an expiring contract for a longer-term contract. The strike prices usually remain the same. For example, rolling over Intel call options expiring in June with a strike price of $20, expressed as “Intel June $20 calls,” to the Intel September $20 calls.
There are two benefits. First, by extending the expiry date, you’re getting three additional months of price appreciation potential in the underlying stock. Second, you’re reducing the net cost of the September contracts by selling the June contracts.
There are three types of rollovers. First, the calendar rollover that involves exchanging expiry dates, such as the Intel June $20 calls for the Intel September $20 calls. Second, the strike price rollover that involves exchanging strike prices, such as rolling over the Intel June $20 calls to the Intel June $25 calls. Third, the combination rollover that involves exchanging both strike prices and expiry dates, such as exchanging the Intel June $20 calls for the Intel September $25 calls. There is a cash outflow when you extend expiry dates, inflow when you bring them in. There is a cash inflow when you move the strike price farther away from the market price, outflow when you bring it closer to the market price.
Online brokerages usually do not provide a “rollover” menu item, which means separate buy and sell orders for each contract. You can also call the brokerage and ask for a “spread ticket” from the options trader. A spread ticket specifies a single price for both the buy and sell sides of the order. The order is filled only if the trader can match your price. For example, if you’re rolling over the Intel June calls to the September calls, enter a single spread ticket to implement the rollover. You can also specify “spread at market” to fill the order at the best market price. This guarantees a fill on your order, but be careful of sudden price changes in fast-moving markets.
Based in Ottawa, Canada, Chirantan Basu has been writing since 1995. His work has appeared in various publications and he has performed financial editing at a Wall Street firm. Basu holds a Bachelor of Engineering from Memorial University of Newfoundland, a Master of Business Administration from the University of Ottawa and holds the Canadian Investment Manager designation from the Canadian Securities Institute.