Summary:
A roll forward takes place when the maturity or expiry date of a futures contract or option is extended beyond the expiry date with the same or a new strike price. This blog details how investors can navigate the tricky terrain of rolling forward.
Introduction to roll forward (extension of options contract)
A roll forward takes place when the maturity or expiry date of a futures contract or option is extended. This can also be done by closing the current contract and opening a new one for the same underlying asset that is longer. This is usually done at the market price at that time. Futures and options contracts have fixed expiry/maturity dates. But with roll forward, investors can extend them beyond the initial expiry date. For the roll forward to be executed, it is necessary to settle the profit/loss on the initial contract. This blog will explain how you can navigate the tricky terrain of rolling forward.
Roll forward – the basics:
In order to execute a roll forward, two processes need to be completed:
- An exit from the initial contract
- Opening a contract with the same asset with a maturity that is at a later date
The tricky part over here is though that execution of both these steps must take place simultaneously so that the effect of a change in the underlying asset’s price is least in terms of erosion of profits/slippage.
How roll forward works:
The manner in which roll forward works will vary depending on the financial instrument that is being traded. For an option, the new strike price for the contract can be the same as the previous one, or a new one may be set. It is called a roll up if the new strike price is higher, and a roll down if it is lower. The techniques are used to mitigate losses, as well as protect profits.
An investor can decide to roll forward an options contract if they feel that:
- Their original expectations are not being achieved and they would like to reposition themselves.
- The timeline for achieving the desired returns is proving to be inadequate and an extension of the expiry date would help.
- Market volatility is expected and there is a need for cushioning against price swings which may have adverse effects.
- They would like to evade an early assignment, more so if the option is felt to be in-the-money.
- This could work as a part of a larger investment plan that would help in the long run. This is known as a collar strategy or a call strategy.
Steps to execute roll forward of an options contract:
While the underlying principle and process of executing a roll forward of an options contract is safe, the following steps should ensure you have a checklist so that you don’t miss out on anything.
- Evaluate your existing position. This will consist of determining the nature of the options (put or call), contract quantity, strike price and expiry date.
- Choose an expiry date that is later than the initial one. This should be one that aligns with your trading objectives and will ensure that you get the intended returns.
- Choose a new strike price if you think it will ensure you get better earnings or stick with the same one if the intention is to just extend the date in anticipation that the results require just a little bit more time.
- Have an estimate of how much your roll forward will cost you in terms of fees and taxes because that will eat into your returns.
- Close the existing contract based on your position:
Bullish position: Sell short put/long call options.
Bearish position: Buy back long put/short call options. - Confirm that your estimates are correct, following which you may review and execute the order.
- Once the call forward has been executed, track how the new contract is performing so that you may be certain that it is in line with the strategy that you are implementing.
- If you feel that there is a slight/minor deviation with the performance of the underlying asset, adjust your position further so that you can make allowances. Need be, you can opt for a roll forward again.
Summing up:
Options trading by itself can be tricky and rolling forward can make things even more complex. Having a planned investment strategy will help have clear expectations with regard to extending the exposure to the underlying asset and adjusting the strike price. The extended maturity dates and changed strike prices can ensure that risks are mitigated and returns are certain, as much as possible. With the help of a professional financial advisor and the steps listed in this blog, making trade decisions for rolling forward options should be easier.