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Michael C. Thomsett is a widely published options author. His "Getting Started in Options" (Wiley, 9th edition) has sold over 300,000 copies. He also is author of "Options Trading for the Conservative Investor" and "The Options Trading Body of Knowledge" (both FT... More
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  • Options Trading: Dangers Of The Forward Roll 1 comment
    Jul 15, 2012 9:01 AM

    The forward roll seems simple and easy, not to mention profitable. It produces additional income. But are there dangers as well?

    Yes.

    You have to make sure the forward roll does not include unintended consequences. For example:

    1. Tax consequences. If the underlying has risen enough points, rolling forward to a later-expiring strike could replace a qualified covered call with an unqualified one. If you have owned the underlying less than one year, the time counting toward long-term tax treatment will be tolled for as long as the unqualified call remains open. You could end up paying short-term gains on profits if and when the call is exercised.

    2. Converting covered calls to naked calls. In a multi-part strategy, you could end up with an uncovered call. For example, if you have created a ratio write and your calls have moved in the money, one exercise-avoidance strategy is to roll the exposed contracts forward. But what happens if the covered calls are exercised? All the underlying shares are called away and you are left with uncovered calls as a result. Now your conservative strategy has been converted to a high-risk strategy. You might be better off cutting losses by closing exposed positions instead of rolling.

    3. Tying up capital longer than intended. The farther out you roll, the more income you receive and, most likely, the more effectively you defer exercise. However, while you originally saw the covered call as a means for fast turnaround due to time decay, your extended exposure means more market risk and a requirement to keep positions open much longer. This create a lost opportunity risk because your capital and margin have to be left in place.

    Before taking any option strategy, including the forward roll, think about the range of consequences. It often makes sense to take a small loss today than to let that small loss erode farther into a much bigger one in two or three months.

    Michael C. Thomsett is an options author with six books on the topic, and two more books under contract with Palgrave Macmillan. His best-selling "Getting Started in Options" (John Wiley & Sons) has sold over 250,000 copies.

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    Author’s reply » Forward rolls are not always safe ...
    15 Jul 2012, 09:03 AM Reply Like
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