In yesterday's edition of Options 101, we discussed a popular alternative to exiting an options position: rolling into another series. In today's column, we're going to make this strategy even more tangible by discussing a hypothetical roll on oil tanker titan Frontline Ltd. (FRO: sentiment, chart, options).
A Quick Review
Briefly recapping what we've already learned, investors who want to extend their strategy over time often opt to roll their positions. Traders can initiate this play for many reasons, whether it's to prolong their "insurance" with protective puts or covered calls, or to give their original forecasts more time to come to fruition.
In order to roll, the options trader would first close out his existing position. He would then open a new position similar to the old, but with a new strike, expiration date, or both. The investor has rolled up if the new position has a higher strike price, and has rolled down if the new position has a lower strike price. By opening a new position with a later expiration date, he has rolled out.
Up and Out with FRO Calls
Before we delve into our example, let's examine our subject from a technical perspective. Since grazing the $16 level in mid-March, the shares of FRO have rallied roughly 56%. What's more, the stock has garnered additional strength from its 10-week moving average, which has acted as support during the past month. Plus, this trendline is poised to make a bullish cross with its 20-week counterpart – often a signal of additional strength on the charts in the intermediate term. At last check, the equity was flirting with the $25.25 level.
Now, let's assume that in late April, when the shares of FRO were hanging out in the $18 neighborhood, our pal Gretchen was fortunate enough to have purchased a June 20 call on the stock. Since the call at the time was out of the money, she paid only $1, or $100 (x 100 shares), for her bullish pick.
It's now mid-June and options expiration is fast approaching. With the equity lingering near $25, Gretchen's FRO June 20 call now harbors an intrinsic value of $5, or $500. She could sell her long position on the stock for a pretty penny ... but what if she still has high hopes for the shares?
Looking at the charts – as well as the stock's fundamental and sentiment set-ups – Gretchen thinks FRO has more room to run. In fact, she now believes the security could surpass the $25 level by July options expiration. For this reason, she elects to roll her position up and out.
First, Gretchen sells her FRO June 20 call for $5, or $500. Subtracting the $100 she initially paid for the option, she's left with a surplus of $400. With that cash Gretchen opts to buy a new 25-strike call – currently at the money – in the further-dated July series of options for $2, or $200. Her portfolio is still $200 ahead, and she can make even more money with her new call position if the shares of FRO extend their recent journey into the black.
Word of Advice
Remember – rolling a position can be an effective way to capitalize on a stock's movement or continue protection on your portfolio. However, don't extend an unsuccessful strategy out of frustration, as you're ultimately throwing away more capital on a losing trade. If you're uncertain about your forecast for the underlying stock before rolling a position, it may be smarter to consider cutting your losses and exiting the strategy altogether.
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The Options 101 column introduces readers to the basics of options trading by exploring rudimentary concepts and terminology, and dissecting the risks and rewards of various strategies. Though this series is designed for option rookies, we hope seasoned options speculators can learn something, too. read more...
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