How weekends affect the theta

[Kim]

I’m asked many times how weekends affect the theta. Is it true that if we buy a straddle on Friday, it will be automatically worth less on Monday due to the negative theta?

The answer is no. Market makers have a system for marking the passage of time. In simple terms, the ticking clock speeds up as we move from Monday to Friday.

The theoretical clock ticks much faster on Friday than on the previous Monday. Market makers are smoothing out the passage of time when taking into consideration that the markets are not open for trading on the weekends.

If the option traders used the ‘true’ Friday theoretical values for their bids and offers, when Monday morning arrived each option would (assuming an unchanged sock price) be lower than on Friday. This would be especially obvious as expiration week arrives. To discourage others from ‘dumping’ option premium of Friday and repurchasing Monday, the passage of time used to determine the value of options is not measured in real time – at least not as weekends approach.

Mark Sebastian discussed this point in detail (Option Pit).

[Marle]

Kim and group,

I was looking at the post on "How weekends affect the theta" as well as the original blog post by Mark Sebastian and was wondering if there is a way to maximize the winning ratio of our trades knowing that theta accelerates on Thursday/Friday. Would it be better, in times of low volatility, if we were in and out of a trade Monday-Wednesday to avoid the acceleration of theta? I wonder if someone could backtest this. I don't have access to TOS.

Thanks,

Mark

[Kim]

First of all, for stock reporting on Thursday, we do enter on Monday most of the time. But if we enter on Friday before the close, then it is no different than entering any other day since the theta already accelerated. Entering on Friday has another advantage: many times there are some news on weekend and the stocks move on Monday which helps our trades. And when trading RIC, it is less critical since the theta is reduced.

[Kim]

Sorry I misread your post.. you are talking about exiting not entering.

We rarely exit on Friday (in fact probably never since companies typically don;t report on Friday AC). For companies reporting on Thursday, I think it is beneficial to wait till the last day in most cases to catch the most of the IV increase. Since in many cases we are playing with weeklies which expire on Friday anyway, the weekend theta is not relevant in those cases.

[mks212]

Thanks Kim. Jeff Augen, in his book, Day Trading Options, discusses an example or two of straddles that lost a good amount of time value prior to easter weekend due to the market being closed on good friday.  It was not a thorough enough discussion, however, so I am unsure.

 

I read the post you referenced on Option Pit and it makes sense.  I actually have a straddle open now and am watching the IV decrease starting yesterday afternoon into today for no apparent reason.  The stock has moved down actually, so if anything IV should be up.

 

Lowering vol is the first option the author mentioned that market makers have so maybe that is what is happening.  I will hold until Tues as planned and see what happens.

 

Mike

[Kim]

Just got the following email today:

 

"Since MLK day is a federal holiday the banks and stock markets are closed; which gives me a day off and option sellers an extra day of theta decay. It’s kinda like making money with no risk."

 

Making money with no risk?? Someone who calls himself OptionGenius should know better than that..