The “jelly roll” sounds like a delicious pastry, but it is also a lesser-known but powerful strategy for extracting hidden yield in the options market. There are plenty of options strategies that focus on bearish or bullish bets, which profit from the prices moving in a certain direction. However, the jelly roll strategy thrives on price and time inefficiencies where traders can take advantage of calendar mispricings and do something called “harvest carry.”
Keep reading to learn more about how jelly rolls work and their delta-neutral nature, which differs from directional plays, which use implied forward pricing discrepancies. We’ll highlight how you can spot good opportunities for using this oft-forgotten strategy and use it to maximum effect.
What Is a Jelly Roll in Options?
We aren’t surprised if you have never heard of the jelly roll strategy in options trading—it’s not commonly discussed, and many traders don’t realize the power that lies in this strategy for extracting yield out of the options markets. Discover what the strategy entails and how it could work hypothetically in a real-world scenario—we’ve provided an example below for clarification!
Basic Definition
The jelly roll strategy is constructed using a synthetic long (long call + short put) and a synthetic short (short call + long put) at the same strike but different expirations. This trade setup is often expressed as a four-leg, zero-delta position:
- Short-Term Synthetic Long: Long call + short put (near-term)
- Long-Term Synthetic Short: Short call + long put (longer-term)
The inherent setup of the jelly roll strategy is zero-gamma and delta neutral, with the ultimate goal of targeting mispricings in calendar forward pricing. The combination that makes up the jelly roll ensures that a portfolio’s value remains relatively stable, even when there are small price movements in the underlying asset. One of the best ways to describe it is that the traders are arbitraging time and not placing bets on the direction of the prices.
Hypothetical Example
Let’s take a look at a simple SPY example to show the construction and net premium of the jelly roll strategy. Keep in mind the trading strategy’s delta-neutral nature, focusing purely on pricing differentials and not direction.
Example
The options trader purchases a 30-day call and, at the same time, sells a 30-day put at the $100 strike. On top of this, they are also setting up another part of the trade. They sell a 60-day call and buy a 60-day put at the same strike.
Implied Forward Price and Carry Trading
Now that the jelly roll is set up, the position ultimately profits based on future changes in the implied forward price. These changes can also result in the jelly roll incurring losses for the trader. To be clear, the implied forward price is the theoretically derived price of an asset for future delivery, and it’s based on the current spot prices and interest rate term structure.
The jelly roll behaves like a carry trade where the position profits from being held over a long period of time, gaining value based on the roll yield of derivatives and interest rate differentials. Carry trades often involve:
- Exploiting the difference between the spot price and the forward price
- Using options contracts to exploit interest rate differences indirectly through the creation of a synthetic loan
- Buying low and selling high by riding up a downward-sloping futures or options curve
- Selling high and buying back low based on an upward-sloping curve
The Mechanics of Calendar Arbitrage
Before we can dive into how calendar arbitrage works, we must first talk about how options imply forward prices, something that is key to know for a complete understanding of how the jelly roll strategy works. There is something in options called “put-call parity,” and there is a formula for it which details what the market expects the stock to be worth by the time of the expiration date.
Put-Call Parity Key Formula
Forward = Strike + (Call – Put)
Determining what the stock might be worth by the expiration date is adjusted for dividends and interest rates. Jelly rolls can be used to great effect when traders discover these market inefficiencies and make money from the differences. However, they must be aware of the main reasons why these mispricings are occurring in the first place.
What Causes Mispricing?
In a perfect world, the market would be perfectly priced, and that would result in perfectly aligned implied forwards across multiple expiration dates. However, we live in the real world, and this is far from being the case. The implied forwards don’t align most of the time, and there are a few different factors that are responsible for these outcomes:
- Skew Distortions—When there are distortions in skew, this can result in discrepancies between implied forwards and true market expectations from other traders. These distortions can create opportunities for calendar arbitrage due to the mispricings that eagle-eyed traders spot.
- Supply/Demand Imbalances—These come as a result of there being a greater number of buyers or sellers than the market can readily accommodate at a certain price level. The imbalances you end up seeing a lot of the time in forward markets can be driven by factors like liquidity issues, market sentiment, or the specific needs of market participants.
- Interest Rate Shifts—Interest rate shifts are caused by economic factors and policy decisions, and they can cause implied forward rates to differ from fair value based on the current spot rates and the expected future spot rates. These short-lived opportunities can arise in the markets, giving traders a short window to conduct some calendar arbitrage if they so choose.
- Dividends—Behavioral factors, differing tax treatments, and market volatility can contribute to mispricings in the options markets, which can open the door for experienced traders to take advantage of the scenario for calendar arbitrage.
Extracting Carry—How Jelly Rolls Capture Yield
Jelly roll strategies are capable of capturing yield in the same way that traders in the bond market can extract carry through a process of rolling the position down the yield curve. Traders can collect premiums from the mispricing that occurs when long-dated synthetic shorts are overpriced compared to the short-dated synthetic long positions. The premium that the trader collects serves as the carry in this situation—it’s an expected gain that happens when the pricing begins to overlap with fair value over time. Earnings ultimately come from the yield curve shape.
Positive vs. Negative Carry Scenarios
Jelly rolls can capture yield through positive carry, but there are also some scenarios where traders will experience negative carry due to a number of market factors, which can result in unfavorable trade outcomes. We’ve outlined an example of positive and negative carry to help you understand the idea.
Positive Carry
When the jelly roll trades for a credit, it implies positive carry. Let’s say the trader does a jelly roll for a net credit of $0.50 per share. Assuming there are no surprises when it comes to interest rates or dividends, the pricing gap will close by the time of the expiration date, and the trader can earn a risk-free return using the jelly roll. It’s important to keep in mind, though, that this is before you factor in slippage or fees.
In this positive carry scenario, the traders are expecting the pricing to revert back to fair pricing, which means the jelly roll isn’t a trader taking a directional market view. Something else worth mentioning is that the jelly roll requires a lot less capital compared to the directional trades and spreads we keep mentioning. This is due to the inherent setup of the jelly roll, which is delta-neutral. The jelly roll is, therefore, a great option for traders who have portfolios with margin accounts.
Negative Carry
Negative carry can set in with a jelly roll strategy when the cost associated with maintaining the position would outweigh any of the benefits that would come as a result of the trade setup. A few of the factors that would result in negative carry for this kind of trade include:
- Option Premium Decay: Negative carry can arise when the long options are decaying faster than the short options are appreciating.
- Market Movements That Go Against the Trade: If the markets move unexpectedly, forcing the position into a certain direction or out of a favorable trading range, the options position could lose more value than the trade originally anticipated. These adverse market movements can, unfortunately, lead to a negative carry.
- Unfavorable Interest Rate Differentials: When the cost of financing options positions is higher than the potential gains due to interest rates that impact those costs, this can result in a negative carry for the jelly roll strategy being used, and it can make this trade setup not at all worth pursuing.
Real-World Use Cases
Jelly rolls are versatile in their uses, and we’d love to show you some real-world use cases to prove how many different scenarios there are where options traders can benefit from this strategy. Not only can they be used around events to take advantage of the mispricings that occur around earnings or Fed meetings, but they can also be used by institutional investors and retail traders alike—jelly rolls might be relatively unknown, but they can work well in a wide array of circumstances.
Institutional Examples
Institutional investors such as hedge funds or market makers can use the jelly roll strategy for several purposes, including the following:
- Capturing dividend mispricings
- Hedging forward exposure (while avoiding directional bias)
- Taking advantage of interest rate differentials
Based on their goals, institutional investors might use long or short jelly roll strategies. A few factors to take into account before using either are the current market outlook and the role that volatility is currently playing in the options markets.
Retail Adaptation
In addition to institutional investors using jelly rolls to their advantage, retail traders may also use these same strategies for trading around underlying assets that are highly liquid. The appeal of using jelly rolls in these environments is that the bid-ask spread for the assets being traded and for the options contracts is narrow, and this lets retail traders enter and exit positions efficiently at fair prices.
Using jelly rolls in liquid underlyings like SPX, SPY, QQQ, APPLE, or TSLA can result in profitable trade scenarios, especially when they’re done around market events like interest rate announcements from the Fed or ex-dividend dates. To make the process easier for retail traders, there are ways to monitor for opportunities using tools like OptionStrat or custom scripts.
Event-Driven Plays
As we mentioned a few times now, there are jelly roll plays that can be executed when certain events arise, which lead to calendar mispricings. This can happen during dividend announcement periods or rate shifts. A profound shift can be seen in pricing when companies announce that they’re going to release an earnings report or when the Fed calls a meeting to discuss the future of interest rates. These situations are rife with possibilities for event-driven jelly roll plays that capitalize on these price misalignments.
Risks and Execution Challenges
Although the jelly roll is an unknown, but possibly lucrative options trading move, it does come with some limitations and risks that anyone should know about before setting one up. Get familiar with some of these risks and execution challenges, so you can properly prepare one and find the right situations where you can use it to maximum effect.
- Execution Complexity: The jelly roll is made up of two horizontal spreads to exploit price differences and four-leg spreads, which require precision and/or algorithms to avoid slippage. While the setup and concept of the jelly roll are relatively easy to understand, executing one correctly can be challenging due to getting timing right with the subtle price discrepancies that their success hinges on.
- Dividend and Rate Risks: The problem that many traders face with the jelly roll is that dividends and interest rate changes can disrupt the strategy and result in less-than-ideal outcomes. For instance, inaccurate dividend forecasts can blow out expected carry, and certain rate assumptions can change, those that are embedded in options pricing. Misestimating ex-div dates or implied interest rate curves can erode expected edges.
- Liquidity Consideration: Jelly rolls are best executed in highly liquid, tight spread underlyings, so dealing with illiquid positions can create a problem for the strategy. It is best to avoid thinly traded options for this strategy, and traders can make the simple mistake of choosing contracts where the spread is wide and there is little open interest.
Comparison with Other Neutral Carry Trades
How does the jelly roll strategy stack up against other neutral carry trades like calendar spreads or box spreads? Check out how these three strategies compare to one another below, where we have outlined how each one is constructed and the goals associated with each trade. You can also learn about the primary risks and rewards associated with each move.
Jelly Rolls
- How They’re Built: The long jelly roll is the combination of a long calendar spread and a short put calendar spread. Each leg comes with the same strike price but different expiration dates. The short jelly roll would be a short calendar spread and a long put calendar spread.
- The Ultimate Goal: The jelly roll profits when there are mispricings between the call and put spreads because of the cost of carry discrepancies, which have to do with changing interest rates or dividends.
- Risk: Jelly rolls can have limited profit potential, and there are several execution risks due to the complexity of the strategy. The jelly roll can also be sensitive to changes in interest rates or dividend payouts, which can have an adverse effect on the overall profitability of the strategy.
- Reward: Jelly rolls offer arbitrage opportunities and let traders capture the cost of carrying the underlying asset.
Box Spreads
- How They’re Built: A combination of two vertical spreads, which include a bear put spread and a bull call spread. The first leg involves burning a high strike put and selling a low strike put, while the second leg involves buying a low strike call and selling a high strike call. Both parts of the trade have the same expiration date.
- The Ultimate Goal: Securing a profit that is equal to the difference between the strike prices upon the expiration date. The box strategy guarantees a risk-free arbitrage opportunity so long as the spread is correctly planned by the trader and bought at a discount.
- Risk: The box strategy does come with brokerage and transaction costs. This strategy is also sensitive to changes in interest rates, and there are significant risks involved with liquidity and execution.
- Reward: Box spreads come with defined and limited risk, offer risk-free arbitrage opportunities, and help traders with capital preservation. A few other perks include a predictable profit margin and the fact that it is a non-directional strategy that operates independently of price movements in the underlying asset.
Calendar Spreads
- How They’re Built: The calendar spread is made up of buying and selling options of the same type that have the same strike price, but different expiration dates. You’re dealing with options that are either calls or puts.
- The Ultimate Goal: The calendar spread’s goal is to make a profit from the time decay of the near-term compared to the longer-term option. Another one of the calendar spread’s goals is to profit from changes in implied volatility.
- Risk: Calendar spreads come with an early risk assignment, particularly with in-the-money options that are near an ex-dividend date. You might also run into some problems when there are unfavorable price movements or an unexpected acceleration in time decay.
- Reward: The calendar spread is a good move when it comes to generating income because traders can collect a premium on the short option. There is also the time decay factor that works to make the calendar spread a flexible trade, plus the calendar spread is a defined risk strategy where the max loss is limited to the cost of opening the spread.
How to Find and Deploy Jelly Rolls
Anyone who is new to using jelly rolls might not be familiar with how to find these trading opportunities and set one up. Keep reading, and we will detail how you can scout out these opportunities using the right scanning tools for getting the job done. For best results, traders should be using alerts and automated systems to detect these setups for the most simplified and streamlined process.
Scouting for Opportunities
If you’re on the search for opportunities to use the jelly roll strategy, you can begin by using real-time option chains to scan for misaligned forwards. Traders can conduct a manual scan by calculating the implied forward price for each call and put price across the two expiries. Once the discrepancies are found, they can construct a jelly roll for net credit.
Automation & Alerts
Traders can take advantage of software or scripting services that scan for jelly roll setups. A few good products that you can look into for this type of automation would be OptionNet Explorer or OptionStrat. As far as scripts are concerned, custom Python scripts are a steady go-to that traders have used to great success.
Not only is it important for traders to focus on liquid tickers where they can enjoy clean setups due to these companies running off of known dividend schedules, but traders can also have a dynamic experience with these investments when they also use scanners or platforms that expose implied forwards, simplifying the entire process altogether.
The Special Edge with Jelly Rolls
Mastering jelly rolls can give traders a more professional-grade insight into how time, interest, and volatility interact. While it’s more of a niche move, at least compared to directional plays like iron condors or butterflies, the jelly roll is an elegant way to extract carry from a market that often overlooks calendar-based inefficiencies.
Perhaps the biggest appeal and advantage to using jelly rolls is that they are a professional-grade approach to extracting yield from calendar inefficiencies. They offer a path with options trading where you are diversifying your trending approach well beyond directional or volatility plays. If you’re interested in gaining the special edge that jelly rolls can offer, you can start by keeping an eye on the options chain during dividend week and then use those setups to do some hypothetical trades using paper trading simulators on your broker app or website of choice.
