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November 29, 2012

Time Decay and Weeklys

One of the effects of the seasonality of options (that I talk a lot about with my options coaching students) is that premium sellers see the most dramatic erosion of the time value of options they have sold during the last week of the options cycle. Most premium sellers strive to keep the options they have sold short (also known as options they have “written”) out of the money (OTM) in order that the entirety of the premium they have sold represents time (extrinsic) premium and is subject to this rapid time decay.

With 12 monthly cycles, there historically have been only 12 of these final weeks per year in which premium sellers have seen the maximum benefit of their core strategy. The advent and widespread use of weekly options has changed the playing field. Options with one week durations are available on several indices and several hundred different stocks. These options have been in existence since October 2005 but only in the past couple of years have they gained widespread recognition and achieved sufficient trading volume to have good liquidity. Further now, there are weeklys that go for consecutive weeks (1 week options, 2 week options, 3 week options, 4 week options and 5 week options) that were just added a couple of weeks ago.

Standard trading strategies employed by premium sellers can be executed in these options. The advantage is to gain the “sweet spot” of the time decay of premium without having to wait through the entirety of the 4 to 5 week option cycle. The party never ends for premium sellers using these innovative vehicles.

Traders interested in using these weeklys MUST understand settlement procedures and be aware of last days for trading. An excellent discussion of weeklies given by Dan Passarelli is available at Learn to Trade Weeklys.

John Kmiecik

Senior Options Instructor

Market Taker Mentoring

August 11, 2010

Buckle Your Seatbelt

Filed under: Options Education — Tags: , , , — Dan Passarelli @ 2:11 pm

My last several options blogs have been about the rapid and dramatic interest in and activity with the weekly options.

The full impact of this weekly options in the options market is not yet known. For the covered call writer, the rapid theta decay of weekly options presents a potential opportunity to collect additional premium over 52 weekly cycles as opposed to the historically available 12 monthly cycles.

Another theoretical result of the tremendous volume of weekly options traded, there is early evidence of a weekly “pinning” effect. Remember that option strike pinning is usually a relatively weak force that heretofore had characteristically been seen the week of options expiration. This phenomenon refers to the tendency for an underlying to close at or close to an option strike price when no other strong directional trends are in play.

Finally, as Adam Warner has pointed out, these options may well reinforce a directional trend that develops after the weekly option premium sellers have taken their positions. Because there is little premium with which to offset adverse directional moves, and also because these short dated options have abundant gamma, premium sellers could be forced to defend their position thus causing exacerbation of directional moves.

Remember that the ancient Chinese character for danger and opportunity is the same. We are dealing with the new arrival of powerful forces which have the potential to change the landscape of the options world.

Bill Burton, MTM Writer