The Weeklys. The Option Pit Method. Option Pit. Understanding Option Structure

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Muriel Franklin
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1 The Weeklys The Option Pit Method Understanding Option Structure Option Pit

2 What You Will Learn What are the Weekly Options When do they list How are they different from regular options How weekends affect options and its relation to weekly trades

3 What is a Weekly The Weeklysare options that expire over the course of one week They expire every Friday They are listed the Thursday in the week prior to the Friday expiration Thus, the options actually have a life span of 8 days, not one week

4 Weekly In order to have weekly options, the option contract must have a specific volume Listing of weeklys is generally consistent, but there are options that can fall on and off the weekly list When a standard expiration is the following Friday, weeklys do not list

5 Index Weeklys Unlike the regular SPX, the SPX weeklys expire in the evening at 3 pm on their expiration date Conform much more closely to SPXPM than SPXAM options Are traded electronically Weeklys also trade in RUT, NDX, and OEX Trade in the ETF s as well

6 Advantages The constant listing of new options makes them great for premium selling plays Allow traders to more easily trade events like earnings, drug announcements, and employment reports Increases the number of spreads and potential combinations of trades that one might want to trade Loaded with Gamma (sensitivity to price)

7 Premium Selling We have all seen this chart: 30 Days Vs 30 Days Vs 8 Days

8 Spreading The high rate of decay allows for more customizable covered calls or short put trades Can allow for new forms of calendar trading Can allow for new types of diagonals and time back spreads Can be great for butterflies as well

9 Trading Events One of the great things about weeklies is pricing straddles ahead of an earnings or event announcement Prior to weeklys, traders had to estimate the amount of earnings in the premium prior to announcement The weeklys allow for a pure event trade

10 High Gamma Traders that want to go long or short can easily play realized vol moves via long or short options This can allow the trader to isolate one Greek easier One key to successful trading is to isolate risk as best as a trader can

11 Disadvantages They may not have a true volatility The Greeks are unreliable Risk Management may be unreliable Have high gamma and have high theta (notice they are also a positive) Are hard to hedge intra month

12 Open Interest One thing to consider is open interest Regular contract months typically have very high open interest relative to weekly options This makes pinning games much easier in weekly options

13 True Volatility Many traders are aware, as options head toward expiration, the model breaks down This make the outputs of that model much harder to produce The Greeks might break The Greeks will have a high drift to them We will show an example in TOS

14 Gamma/Theta While a high gamma and high theta may seem great, they also come with a lot of risk The weeklys leave less margin for error if they are not managed properly Spreads, because of drift, will quickly see gamma and theta explode Explosion can make intermonth hedging and intramonth hedging difficult

15 Weekend Decay As many of you know, the option pricing model assume options have a constant decay The problem is they only trade 5 days a week So if a trader sells on a Friday and buys back on a Monday, will the trader get 2 full days of decay for free??? NO!!!!

16 TANSTAFL!! There Ain t No Such Thing As A Free Lunch The overnight decay associated with a weekend should equate to about the same decay as a wake up or Close to Open risk Believe it or not, the market makers actually begin taking decay out as early as Tuesday on regular options

17 The Math Suppose a 5.00 option that is a 30 IV has the following greeks on a Thursday morning Theta:.25 Vega:.50 All other things remain equal By Friday traders would assume the option would be worth 4.50 with an IV of 30

18 What Happens The option is actually worth 4.00 and has an IV of 29. What happened? Another.50 came out of the option for the weekend Since the model can t fast forward, it adjusts the IV instead of the time to expiration Thus the (for weekend)=iv of 29

19 Monday When the options begin trading on Monday, magically, the options IV will increase back to 30%. This is not magical at all, it is the model adjusting for the fact that 2 days passed and very little decay came out of the options Why? Because it was already taken out!

20 Why Do You Care The weeklies trade for only 8 days They are listed on a Thursday This means that, of their first 4 days of existence, 2 of them are weekend! How do traders think this would affect option prices on Thursday?

21 Thursday Thursday there is a race to get as much decay out of the options as possible without over selling the weeklys This can cause the premium to fluctuate It can make early selling advantageous However, options can become oversold early This can cause premiums to rally and fall with the market place

22 Friday By Friday early, all of the weekend is likely to be out of the options They almost always get oversold Can be a GREAT scoop ahead of weekend, as the gamma can essentially become free Understanding the ebb and flow of premium can make trading weeklys much easier

23 Summary Ratio spreads have many advantages They allow traders to hone in on vol, direction, or both They also can be complicated A front spread can be a pure vol play A back spread may be a great directional play

24 Next Time Trading the weeklys using short premium Then the weeklys and long premium! Make sure to keep checking us out!

25 Contact Information Try our services for 1 week, for.01 Mark Sebastian COO OptionPit.com mark@optionpit.com Or call us at Also Check out the Gold Course:

Principles of Risk Management

Principles of Risk Management The Option Pit Method Option Pit What We Will Discuss What is Risk Management Where to Start with Risk Management Money Management: Money Plan Portfolio Management: Trading