Editor’s note: We recently looked at the calendar trade as a premium collection strategy—why an option trader might wish to put on a calendar spread, how theoretical values change during the life of the spread, and what to consider as the spread approaches expiration. This follow-up installment discusses considerations for when and how to roll a calendar spread.
So you’ve put on an at-the-money calendar spread in XYZ (which is trading around $50 a share) by buying a deferred-month 50-strike call and selling a nearer-term 50-strike call. Fast-forward a few weeks. How did the spread fare? In other words, looking at figure 1 below, are you above or below that breakeven line? Hint: If the underlying hasn’t strayed too far from the 50-strike, you’re probably in the black thus far.
Regardless of your answer, you’re nearing the time when a decision needs to be made. Your short leg will soon expire, and if you do nothing before expiration, you could be left with half a spread. Plus, if your option is in-the-money (ITM) at expiration, are you prepared to either deliver the underlying, or take a short position in it?
Now We’re Rolling
You might consider liquidating the entire spread by closing out both legs. But another idea is to roll the short leg. The term “rolling” simply means moving an option from where it is now to somewhere else. That could be a different expiration, a different strike, or both.
When the short option in a calendar spread is nearing expiration, you might decide to roll it out to the same strike in another expiration. This can be accomplished by buying your short option to close, and selling to open the same strike on another expiration date. Just make sure that the expiration you roll to isn’t further out in time than your long option. Recall from the previous article that part of the rationale of a calendar spread is positive theta—nearer-term options generally decay at a faster rate than longer-term options.
Here’s an example using the theoretical option values from table 1 below. Let’s say you’re long the 50-strike call with 43 days until expiration and short the 50-strike call that expires in one day. A roll would involve buying the expiring option to close and selling another 50-strike call with an option that has fewer than 43 days left until expiration. Because this roll involves selling an option with more time to expiration than the option you’re buying to close, you should be able to roll for a credit. You also need to consider the transaction costs and margin requirements on the new position.
|Days to Expiration||50-Strike Call Value||Current Option Position||Option Order to Roll Position|
|1||$0.50||Short||Buy to close|
|8||$1.15||Sell to open|
|15||$1.45||OR sell this one?|
|22||$1.65||OR this one?|
|29||$1.80||OR this one?|
TABLE 1: THEORETICAL OPTION VALUES. Call option prices for weekly options with the underlying stock at $50.30. Rolling the position involves buying the short leg (50-strike call with one day until expiration) and selling another, such as the 50-strike call with 8, 15, 22, or 29 days until expiration. Sample data for illustrative purposes only.
Choosing a Strike
Which expiration you decide to roll to is up to you. There are no hard and fast rules, and like most option trading decisions, there are trade-offs. Options decay more quickly the closer you get to expiration; that’s the nature of theta. So you might choose to roll to the eight-day option. And assuming the underlying has stayed in a range near the 50 strike, you could roll it again next week, and the next week. With weekly options, there’s an expiration on any given Friday. You could continue each week until you get to your long strike. At that point you’ll likely want to liquidate both legs of the spread.
The potential issue with this strategy is transaction costs. The more often you place a trade, the more often you’ll incur costs. So you might instead decide to roll to the 29-day option. The premium, and thus the credit you’ll receive, is higher than it is for the eight-day option, but you won’t have as many opportunities to repeat the process before it’s time to liquidate the entire spread.
Other factors in your decision include:
- Has the underlying strayed from your strike? If so, you might want to consider a different strike—theta is typically greatest in the at-the-money (ATM) strike. But remember: changing strikes will affect price expectations and may impact margin requirements as well.
- Is there an earnings release or other news pending in the underlying? This can mean a higher implied volatility, which generally translates into a higher-than-normal price for short-term options, but can also mean excessive price fluctuation right when you’re looking to roll the position. Some option traders like trading around earnings; others try to avoid it.
Calendar spreads can be effective in times of low volatility, and are potentially useful if you think the underlying might stay within a tight trading range in the near term. The mechanics of setting up and rolling calendars might seem intimidating at first, but after you break them down into individual parts and individual decisions, you might see it as a strategy to consider.