A pick-up in market volatility usually sees an increase in the number of attractive trading opportunities. However, this type of trading environment can also test existing positions in our portfolios.

When a position gets tested (i.e. starts losing money), traders have a number of choices available to them, including:

  • Closing the tested position

  • Reducing exposure in the tested position

  • Letting the position work (i.e. doing nothing)

  • Rolling the tested position into a longer-dated expiration

While any of the choices listed above may fit a particular situation, a new episode of Best Practices explores the fourth bullet point - rolling - in greater detail.

As outlined in this episode of Best Practices, the crux of every rolling decision revolves around "time." When a tested position approaches expiration, there are fewer opportunities for it to climb back to break-even, or positive territory - too much sand has already passed through the hourglass.

When executing a roll, a trader closes the original near-term position, in favor of simultaneously opening the same (or similar) position in a longer-dated expiration. During a roll, the trader may also elect to adjust the strike(s) of the position, in addition to the time until expiration.

On Best Practices the hosts provide a broad perspective on the concept of "time” as it relates to trading options. In order to help reinforce the concepts discussed, they highlight a recent tastytrade study that helps provide illumination on how rolling helps maximize the potential benefits of “extra” time.

The key to this study is that it specifically focuses on "tested positions" - meaning the question of whether or not to roll was paramount and pertinent.

The next aspect of the study that is important to highlight, are the two different groups of positions that were backtested. Basically, the study separated all tested positions into two groups - those with less than four weeks left until expiration, and those with greater than four weeks left until expiration.

For the group of positions with less than four weeks until expiration, a roll was automatically executed, which moved the tested position into the next expiration cycle. Alternatively, the positions with greater than four weeks left until expiration were left alone, and allowed to expire on their own.

As you can see from the design of the study, the goal was to use historical data to help traders gain more context on how rolling decisions affect the bottom line - especially when playing defense.

The study used data in SPY dating from 2005 to present, and utilized one standard deviation short puts. The results of the backtests for each group are compiled in the slide below:

Understanding Time

As you can see in the graphic above, the decision to roll a tested position improved trade performance in terms of win rate and average P/L, as compared to leaving the position alone (i.e. doing nothing).

While this backtest was somewhat limited in scope (utilizing only one underlying), the findings do provide “food for thought” that may help traders optimize their approach going forward.

We recommend reviewing the complete episode of Best Practices focusing on rolling tested positions when your schedule allows.

If you want to explore the concept of time as it relates to options trading further, another show worth reviewing is Best Practices: Vega Over Time.

Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.

Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.