What it means
In options, a strike price is the fixed price at which the contract lets you buy or sell. Rolling down means closing your current option and opening a new one, usually in the same expiry month, with a lower strike.
A trader who sold a call option and sees the share price drop may roll down to collect fresh premium at a more realistic level. Covered call writers use this approach often.
A covered call is when an investor owns shares and sells a call option against them to earn income. If the shares fall, the original call at a higher strike earns little, so the investor buys it back and sells a new call at a lower strike to keep generating income, though the lower strike caps future gains sooner.
Roll-down in the bond market is different. In a normal market, longer-term bonds yield more than shorter-term ones.
As a bond ages, it becomes a shorter bond, and if the curve is unchanged its yield falls towards the lower yield of shorter maturities, which pushes its price up. Bond investors count that price gain as part of the expected return, along with the interest paid.
Funds sometimes buy bonds at the steepest part of the curve to capture it. The strategy can work well in calm markets with a stable curve, but if yields rise across the board the gain disappears or turns into a loss.
The nuance in both meanings is that rolling is not free. Option rolls cost trading commissions and bid-ask spreads and may lock in a loss on the closed contract.
Bond roll-down depends on the curve staying where it is, which nobody can guarantee.
In practice
Real-world examples.
Example
A covered call writer owns a retailer's shares that have slipped from $60 to $52. She rolls her $65 call down to a $57 strike to earn extra income while keeping the shares.
Example
A bond fund manager buys seven-year government bonds because the curve is steep between seven and six years. She expects to earn the coupon plus a price gain as the bonds age.
Example
A corporate treasurer who sold put options to buy back shares rolls them down after the share price falls, lowering the price at which the company would buy.
Formula
Calculation
Net credit from an option roll = Premium received on new option - Cost to buy back old option
Roll-down return on a bond is approximately Modified Duration x (Yield today - Yield after one year of ageing)
Worked example (options): An investor owns 100 shares trading at $48 and is short one $55 call. She buys it back for $0.40 per share and sells a $50 call in the same month for $1.60 per share.
Net credit = $1.60 - $0.40 = $1.20 per share, so $1.20 x 100 = $120 for the contract.
The new cap on her shares is $50, so her maximum price gain is now ($50 - $48) x 100 = $200 plus the $120 credit, compared with the old cap of $55.
Worked example (bond): A five-year bond yields 4.0% and a four-year bond yields 3.5%. The bond's modified duration is about 3.7. After one year it becomes a four-year bond.
Roll-down price gain is about 3.7 x (4.0% - 3.5%) = 3.7 x 0.5% = 1.85%.Case study
Seen in the real world.
Oakbridge Capital is a fictional fund that ran a covered call strategy on a basket of shares. In this illustrative case, the shares fell 8% in a month and the original calls with strikes 10% above the old prices were almost worthless.
The portfolio manager rolled the calls down to strikes 3% above the new prices, collecting an average of $0.90 per share of extra premium. This income softened the fall in the portfolio.
When the market recovered sharply, the lower strikes capped the gains, and the fund lagged a plain share portfolio by about 2%. The manager concluded that rolling down is a way of trading future upside for income now, and the team documented the policy so clients understood the trade-off.
Watch out
Common mistakes.
- Viewing a roll as a free fix. Each roll has costs and may lock in a loss on the closed position.
- Forgetting the lower cap. Rolling a call down reduces the profit you can make if the price recovers.
- Assuming bond roll-down is guaranteed. It depends on the yield curve staying the same shape, and a rise in yields can wipe it out.
Questions
People also ask.
What is the difference between rolling down and rolling up?
Rolling down moves to a lower strike, while rolling up moves to a higher one, usually after the price has risen.
Does rolling down change the expiry?
Not necessarily. A roll that changes only the strike is called a vertical roll, and one that also changes the date is a diagonal roll.
Why do bond managers care about roll-down?
It adds to the expected return beyond interest and can be a significant part of total return in a steep yield curve.
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