Options are contracts to buy or sell a share of stock or a futures contract. A put option entitles the owner to sell a specified security at a specified price until the option expires. A call entitles the owner to buy a specified security at the call price until the option expires. They can be used to hedge your long or short positions against unforeseen market movement. They are also inexpensive ways to trade the markets, but since they have specified expiration dates, traders are often forced to buy more time by rolling forward their options positions.
1. List your options positions according to your original intent in either buying or writing them. If your intent was to hedge portfolio positions, it is likely that you will want to roll and adjust your hedges. If your intent was to use the options as trading vehicles, re-evaluate your original trading strategy in light of market conditions, then decide whether you wish to maintain your put or call positions.
2. Pay attention to the expiration dates of your option contracts. If you intend to roll them forward, remember that their value decreases rapidly as the expiration date nears. Use an options calculator to figure how much time value is part of the contract price and roll your position before the time value begins to drop significantly. This provides some money to use toward replacing the front month contract with a back month contract.
3. Roll options you own by selling the front month and buying the back month. This means you sell the option that is about to expire, using the proceeds of the sale to purchase an option that has more time till expiration.
4. Roll options you have written by purchasing the expiring options, or front month, and selling or writing option contracts with a longer time to expiration.
- A put option is written or created by someone who is willing to buy the stock (or futures contract) at the strike price and usually doesn't think the stock or future will trade low enough to make sense selling it at the strike price. Writing an option also earns the writer additional revenue by selling the put. Generally, the writer of the call is a person who actually owns the stock, wants to earn extra money on the position and doesn't think the stock is likely to trade high enough in the open market to have the stock called away.
- Options are popular trading vehicles because they require small amounts of money to control large blocks of securities, and can result in significant profits. They can also result in total loss of your investment if the options contract expires.
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