One of the more advanced techniques options traders use to reduce risk and increase the probability of success of the trade, is to roll contracts from one month to the next. Today’s show focuses exclusively on rolling options forward, by showing you two different case studies in TLT and IWM. Both trades took multiple months to turn a profit and multiple rolls of our contracts. I’m going to also go out on a limb and say that this podcast is potentially one of the most favorite ones I’ve recorded because I truly believe this concept can help change trades that go against you for the better – and turn losers into winners.
Key Points from Today’s Show:
- When it comes to losing trades, you should rarely lose the full amount.
- There is a lot you can do to reduce the risk or turn the trade around by rolling and extending your trading duration.
Example: If 30% of your trades are going to be losers, if you can turn 5% of those around into profitable trades that turns the zero-sum game around and flips it on its head.
- The strategies and techniques are universal to all industries that you make the trade in — the concepts work across all different types of sectors and underlyings.
- There is a cyclicality in both directions, so if markets go up sometimes they go back down, and vice versa.
- If you understand the natural ebb and flow of the market, you will understand why the rolling strategy works well for options sellers.
CASE STUDY #1: TLT (Bonds)
- Entered the initial trade in TLT on January 9, 2018.
- Sold an iron butterfly for a $3 – a $3 net credit.
- Sold the 124 iron butterfly in TLT.
- The true break-even point is 127 on the call side and 121 on the put side.
- Ideally, TLT needed to be trading between 127 and 121 by February expiration.
- TLT had been range-bound for basically the entire back half of 2017.
- Almost immediately after we sold the spread, TLT started to move down in dramatic fashion as the markets got more volatile in February of 2018.
- As the market started to move down, our position quickly went under water.
- We had almost no opportunity to actually close out of the position, barely showing a profit at all.
- By expiration, it moved all the way down to 118, effectively seeing almost a 2 standard deviation move in TLT.
- At that time period we could have closed the position and banked 100% of the loss, but we decided to take a different approach.
- Moved the position from the February expiration contracts out to the March expiration contracts.
- Closed the February position and re-opened the exact same trade in the March contract, which is called the “rolling trade” — rolling the position from one month to the next month.
1. Make sure that you are not paying to extend your time.
- If you are going to take conceivably more time and risk, you need to get compensated for it.
- With any adjustment or rolling trade, you first order of business is to reduce risk.
- Reduce the risk in the trade so that if the trade still goes bad the next month, you lose less money.
- This means you will always take in a net credit when you roll contracts.
- In the case of TLT, we rolled the put side out using a vertical roll order.
- Closed the February contracts and reopened the March contracts.
- Rolled that side out for a debit of 30 cents
- Sold the March call contracts for 34 credit, which nets out to 4 cents credit.
2. Extend time to see if position turns around.
- This gives you the opportunity to participate if the stock turns around.
- The extended time could give you the chance to turn a loser into a winner (or simply lose less).
- At March expiration, TLT did not move or rebound.
- Rolled the contract out again to April.
- This time IV was a little bit higher, the put side was rolled out for a 10 cent credit.
- Sold the 124-129 call spread again, for 19 cents with a net credit of 29 cents.
- Risk on every iron butterfly was reduced by another 29 cents.
- At April expiration, TLT moved up early in the April cycle to 122.
- We were able to close out of the position completely for a $285 debit, leaving us with $70 winner on the trade.
- At the end of the day, we were left with a total credit of $333.
- This created a $48 profit for each contract.
CASE STUDY #2: IWM (Major market index)
- For this case study, the trade position was first entered on November 15, 2017.
- Did a wide iron butterfly and the initial position took in a credit of $629.
- Sold the 145 calls and the 145 puts.
- Bought the 157 calls and the 133 puts.
- At expiration, there was no opportunity to close the trade out for a profit.
- Held the trade until January expiration, and the market continued to run higher.
- Rolled contracts out to the February expiration cycle.
Roll Trades to Next Expiration Cycle:
- Since IV was higher in January than it was in November, we were able to roll the contracts for a huge credit to the next month.
- Rolled all of the strikes out to the next month expiration (the exact same positions).
- Moved the outside legs out for a 109 debit, and the inside legs out for a 143 credit.
- This created an overall credit for the roll, increasing the total credit in the trade to $663.
- Reduced risk on the trade overall.
- The market fell all the way down to $145, which was our exact level needed.
- We were able to close out of the contracts for a $588 debit.
- Overall, made $75 on every contract that we sold.
CASE STUDY #3: OIH (Commodities)
- In December of 2017, OIH had a spike in IV.
- Sold premium in the January 2018 contracts, selling the 24 call and put (short straddle) for $190 credit.
- At expiration in January, OIH had been range-bound in the $23 to $26 range.
- The market started to move almost immediately against our position, with very little opportunity to close it out at a profit.
- By the time we reached January expiration, 2018, OIH was trading closer to $29.
- Rolled our straddle, using a double diagonal order, with a 3 cent credit.
- This is a testament to our back-testing analysis, which gave really clear signals that OIH was either going to stop moving higher or start moving lower at expiration.
- The day after January expiration, OIH started a huge downward slide.
- OIH fell back down from 30 back down to 24.
- We were able to close the contracts for $179 debit.
- What you ultimately need to do in options trading is give yourself an opportunity to win.
- Sometimes that requires a little bit more patience and a longer trading cycle than you may have wanted.
- Some trades just don’t go the way we want them to right off the bat.
- This has nothing to do with the way you set up the position, it’s just something that will happen.
- Instead of throwing in the towel on a losing trade, look at your choices for rolling, look at your choices for making an adjustment or a hedge trade and figure out how you can reduce risk and extend the trading timeline.
- Rolling contracts is a great way to achieve this (if you keep your position size mall).
- Markets are cyclical and they will come back around. If they don’t, at least you reduced risk in the process.
Free Options Trading Courses:
- Options Basics [20 Videos]: Whether you’re a completely new trader or an experienced trader, you’ll still need to master the basics. The goal of this section is to help lay the groundwork for your education with some simple, yet important lessons surrounding options.
- Finding & Placing Trades [26 Videos]: Successful options trading is 100% dependent on your ability to find and enter trades that give you an “edge” in the market. This module helps teach you how to scan properly for and select the best strategies to execute smarter option trades each day.
- Pricing & Volatility [12 Videos]: This module includes lessons on mastering implied volatility and premium pricing for specific strategies. We’ll also look at IV relativeness and percentiles which help you determine the best strategy to use for each and every possible market setup.
- Neutral Options Strategies [7 Videos]: The beauty of options is that you can trade the market within a neutral range either up or down. You’ll learn to love sideways and range bound markets because of the opportunity to build non-directional strategies that profit if the stock goes up, down or nowhere at all.
- Bullish Options Strategies [12 Videos]: Naturally everyone wants to make money when the market is heading higher. In this module, we’ll show you how to create specific strategies that profit from up trending markets including low IV strategies like calendars, diagonals, covered calls and direction debit spreads.
- Options Expiration & Assignment [11 Videos]: Our goal is to make sure you understand the logistics of how each process works and the parties involved. If you don’t feel confident in the expiration processes or have questions that you just can’t seem to get answered, then this section will help you.
- Portfolio Management [16 Videos]: When I say “portfolio management” some people automatically assume you need a Masters from MIT to understand the concept and strategies – that is NOT the case. And in this module, you’ll see why managing your risk trading options is actually quite simple.
- Trade Adjustments/Hedges [15 Videos]: In this popular module, we’ll give you concrete examples of how you can hedge different options strategies to both reduce potential losses and give yourself an opportunity to profit if things turn around. Plus, we’ll help you create an alert system to save time and make it more automatic.
- Professional Trading [14 Videos]: Honestly, this module isn’t just for professional traders; it’s for anyone who wants to have eventually options replace some (or all) of their monthly income. Because the reality is that mindset is everything if you truly want to earn a living trading options.
Option Trader Q&A w/ Brian
Trader Q&A is our favorite segment of the show because we get to hear from one of our community members and help answer their questions live on the air. Today’s question comes from Brian, who asks:
I have been “pretending” to trade for about two years now. I have been unsuccessful and not very consistent. I have been reviewing the Option Alpha material and website looking for more information on Theta. I have really been trying to find how Theta decay works. I have seen the graph that you’ve presented before, but I’m trying to find out if there is a difference between Theta decay and the graph associated with that when you’re looking at options that are in the money, at the money, and out of the money and how to either maximize or minimize Theta decay based upon choosing the strikes in relation to the actual stock price?
Remember, if you’d like to get your question answered here on the podcast or LIVE on Facebook & Periscope, head over to OptionAlpha.com/ASK and click the big red record button in the middle of the screen and leave me a private voicemail. There’s no software to download or install and it’s incredibly easy.
PDF Guides & Checklists:
- The Ultimate Options Strategy Guide [90 Pages]: Our most popular PDF workbook with detailed options strategy pages categorized by market direction. Read the whole guide in less than 15 mins and have it forever to reference.
- Earnings Trading Guide [33 Pages]: The ultimate guide to earnings trades including the top things to look for when playing these one-day volatility events, expected move calculations, best strategies to use, adjustments, etc.
- Implied Volatility (IV) Percentile Rank [3 Pages]: A cool, simple visual tool to help you understand how we should be trading based on the current IV rank of any particular stock and the best strategies for each blocked section of IV.
- Guide to Trade Size & Allocation [8 Pages]: Helping you figure out exactly how to calculate new position size as well as how much you should be allocating to your each position based on your overall portfolio balance.
- When to Exit/Manage Trades [7 Pages]: Broken down by option strategy we’ll give you concrete guidelines on the best exit points and prices for each trade type to maximize your win rate and profits long-term.
- 7-Step Trade Entry Checklist [10 Pages]: Our top 7 things you should be double-checking before you enter your next trading. This quick checklist will help keep you out of harms way by making sure you make smarter entries.
Real-Money, LIVE Trading:
- EWZ Iron Butterfly (Closing Trade): After nearly pinning the stock at our short strikes, and thanks to the volatility drop, we netted a $600 profit on this iron butterfly trade.
- VXX Short Call (Closing Trade): One of the most consistent and profitable options trades we can make is shorting pure volatility with VXX and today we closed this naked short call in VXX after a couple days for a $420 profit.
- DIA Iron Condor (Adjusting Trade): This neutral iron condor in DIA is need of a quick adjustment early this week as the market continues to rally. In this video, we’ll discuss why I’m adding an additional put credit spread while also choosing NOT to close out of our current put credit spread due to pricing reasons.
- COP Short Put (Closing Trade): These single short puts in COP acted as a great hedge for our other bearish bets in oil this month and helped smooth out our returns after we closed them for a nice big profit.
- TSLA Put Debit Spread (Closing Trade): Although many people thought we were crazy for getting bearish in TSLA this pre-earnings put debit spread trade made us $200 today. After the huge run up from $140 to $260 and getting some technical sell signals, we were pretty sure this stock would pull back.
- MON Iron Condor (Closing Trade): Following a huge drop in implied volatility we worked hard to close this MON iron condor trade adjusting the order multiple times to fill before the end of the day.
- IBB Call Debit Spread (Opening Trade): We’ll show you how I started searching for a new bullish trade and eventually found a low volatility trade in IBB looking for a move higher to hedge our portfolio.
- TLT Iron Butterfly (Closing Trade): Following the Brexit vote TLT and bonds traded in a nearly $8 range really quickly – even still the drop in implied volatility helped generate a $330 profit for us.
- XBI Call Debit Spread (Closing Trade): Got lucky picking the exact bottom for our entry in this call debit spread for the XBI biotech ETF which ultimately was closed for a profit of $165 today on the rally higher.
- COH Iron Butterfly (Earnings Trade): Shortly after the market open we close out of our COH earnings trade for about a $160 profit, leaving just 1 leg on to expire worthless.
- EWW Debit Spread (Closing Trade): Using some of the technical analysis signals we discovered in our backtesting research, we were able to make a quick $130 profit on this bearish EWW debit spread trade.
- IBM Iron Condor (Earnings Trade): Shortly after the market opened you’ll follow along with me as we watch volatility drop and liquidity come into the market before closing out the position for $250 profit.
- SLV Short Straddle (Opening Trade): Using our watch list software we decided to continue to add to our existing SLV short straddle position with a new set of strike prices reflective of the move lower in the ETF recently.
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