Rolling the Position
Time spreads are unlike all the other strategies in regards to rolling or continuing the position. In other strategies, the option component is limited to a single month. The position disappears at expiration. It either transforms into stock or expires worthless leaving you with no option position. This is not so in the case of a time spread where you are dealing with two different expiration months.
After the front month expires, in addition to a potential stock position, you still have an option position. The out-month option still has time until expiration. You must first understand the new position you have inherited to properly roll it.
Rolling the Call Spread
Look at the call time spread first. For the purposes of our example, pretend we are long the September / October 25 call spread. If the stock closes below $25.00 on expiration Friday of September, the September 25 calls will expire worthless leaving you with a long October 25 call position. You have several things that you can do from this position.
First, you can sell out the October 25 call. Perhaps, the combination of the expiration of the September 25 calls and their subsequent worthlessness along with the proceeds gained from the sale of the October 25 calls after September expiration might make a profitable trade.
You can also keep the position open and continuing in several ways. You can stay long the October 25 call naked. You can sell the October 30 call and become long the October 25 / 30 vertical call spread if you are bullish. You can sell the October 20 call and become short the October 20 / 25 vertical call spread if bearish.
You can buy the October 25 puts and become long the October 25 Straddle if you feel the stock would become volatile. You can even sell the stock and create a synthetic put if you are very bearish. There are ways to create a new position that reflects any possible outlook an investor has.
If the stock closes above $25.00, then the September 25 call will close in-the-money. At that time, you will be assigned your short September 25 call and that translates into a short stock position. The short stock position that you receive from the assignment of your short September 25 call, along with the remaining October 25 long call position, is the equivalent of a synthetic put. At this time, you can close out the position or keep it.
The position is a bearish one, so if you feel the stock may head down, you can keep the position on. You can sell another option of a different strike to set up either a bull or bear put spread. You can buy the October 25 call to create a long Straddle. As you see, many different combinations are available.
If you are short the September / October 25 call time spread and the stock expires under $25.00 on expiration Friday in September, then you will have a remaining position of a short October 25 call naked. There are many potential ways of continuing the position. You can always buy back the naked call and close the position if you no longer want to maintain a position in the stock.
If you do, you can buy a call in the same month and create a vertical spread, sell the corresponding put and create a short Straddle, buy the stock one-to-one and create a buy-write or other combination based upon what you feel the stock will do.
If the stock closes above $25.00 and you are short the call time spread, you will have with a long stock position from your long September 25 call and short the October 25 call against the long stock position. The position that remains is a buy-write. Depending on your outlook for the stock, you can keep the buy-write on, take it off or use other options to change the position to what you want it to be.
Rolling Put Spreads
Let us see where we are when the front month option expires. We will use the September / October 25 put spread for our example. When long the spread, and the stock closes above $25.00, the September 25 puts, which you are short, will expire worthless leaving you with a long naked put position. From that position, you can close it or combine it with other option or stock to create a different position. Again, there are many different possibilities.
If you are short the put time spread, and the stock closes above $25.00, then the September 25 put (which you are long) will expire worthless leaving you with a short naked put position in the October 25 puts. This position may be closed out or combined with other options or stock to create a strategy, which will take advantage of the outlook you have on the stock.
When the stock closes below $25.00, the scenario is different. When long the spread with the stock closing lower than the strike price, the front month put which you are short will be assigned to you thus making you long stock in addition to your long October 25 put. This position is known as a synthetic call.
There are many ways to combine other options and/or stock to change the position so that it is in line with what you want it to be going forward.
If you were short the spread, and the stock closed below $25.00, then you would exercise your long September 25 put making you short stock and short the October 25 put. That position, which is called a “sell-write” (the sister strategy to the buy-write), can be kept as is, closed out, or changed in different ways by combining it with stock or other options based upon your expectations of the stock’s future movements.
Closing the Time Spread Position
It is important to remember that the time spread will leave you with several potential positions that can be altered by other options or stock in numerous ways. There are a number of decisions you must make to clarify your understanding and goals.
First, it is important to understand what position remains when the near-month option expires. Second, you must decide what you think the stock is going to do (formulate a bullish or bearish lean) and then figure out the best way to take advantage of that opinion. Next, you must figure out how to adjust your present position and change it into an advantageous one for a profitable outcome. That might mean selling out of the position totally. Your changes to the position must not only be correct, but also done in the most efficient, cost-effective manner including keeping commission prices down.
It is also important to note that you should go from one hedged position to another to ensure proper risk management.
The time spread is an excellent strategy for premium sellers who want to capture premium in a hedged way. It is ideal for stagnant periods when a stock is likely to remain in a tight price range. Time spreads are less expensive and less risky than almost all other premium collecting strategies, so it is friendlier to investors who are short on capital and experience. Time spreads can also take advantage of volatility changes and even some directional stock movements.
The time spread can leave you with a residual naked position, which needs to be managed for risk at expiration of the front month option. It is important to fully understand the risks and rewards of the strategy and the potential risks and solutions of the residual position before execution.
The residual position affords you many choices including closing out the position totally, or continuing the position by combining it with either stock or another option to create a new position that fits the investor’s new expectations for the stock.