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When best to roll an option ? case study.

Discussion in 'Options' started by traderjean, Jun 19, 2008.

Hello everybody,
I have a little assignment to do about rolling option contracts. The question is quite simple: When is it best to roll an option thatâs deep in the money if the market is going to keep going down, let me be more precise.

** Case nÂ°1 :
We are short puts 47 June, the stock is currently trading at 46.5. To roll to the next month we want to buy the June 47 put at \$0.80 and sell the July 45 put at \$0.65. The cost of rolling is therefore \$0.15 (80-65). Now the market drops to 44.5; The July 45 put is now worth \$1.60.

** Case nÂ°2 :
We are short puts 47 June, the stock is currently trading at 46.5. The stock drops at 44.5. We now decide to rollover and the 47 put is now worth \$2.50 and the 45 put July is at \$1.60. The cost of rolling is therefore \$0.90 (2.50-1.60).
So I have done all the pricing of different options but Iâm stuck on one thing. It could seem like itâs more profitable to roll when the market trades at 46.5 in case 1 since it costs \$0.15 compare to rolling at 44.5 when it costs \$0.90.

BUT, should I take into account the fact that the 45 put july sold at \$0.65 and now worth \$1.60 is a shortfall. Since we rolled when the stock was trading at 46.5 and it is now at 44.5.

1000 of equity
-15 for the cost of rolling 47 to 45
= 985
-160 since the 45 has risen in value (thatâs the part im not sure)
= 825 with the market trading at 44.5