SteadyOptions is an options trading forum where you can find solutions from top options traders. TRY IT FREE!

We’ve all been there… researching options strategies and unable to find the answers we’re looking for. SteadyOptions has your solution.

Accurate Expiration Counting


Options traders are rightfully concerned with the number of days to expiration of an option. At the time the position is opened, whether long or short, the issue of time decay must be at the forefront of risk evaluation. But is this performed accurately?

Most listings report days to expiration on a calendar basis. A one-week expiration is expressed as 7 days, even though only 5 trading days remain. The defense of using calendar days is because time decay continues to occur even on days when markets are closed. For example, between the Friday prior to expiration (with 7 days remaining) and Monday (one session later but 3 calendar days later), about one-third of remaining time value typically disappears. For those writing short-term short positions, this is a significant fact. By selling a position on Friday and opening to close on Monday or Tuesday, a profitable result is more likely than not. This assumes no significant movement in the underlying.
 

Although the opportunity is a great one, so is the risk. With three days transpiring between Friday and Monday, many changes are possible. The evolution of option pricing is not dependent solely on time decay. Volatility is also a factor.


However, volatility is not as severe a risk factor on weekends as many traders believe. It is true that changes can occur, and that a logical position could end up losing due to unexpected changes, often for reasons not fully understood. The “weekend effect” occurs due to lack of market activity. With markets closed, when large volume of selling takes place on Friday, lower implied volatility follows on Saturday and Sunday. The danger in this is relying on the weekend effect, because on Monday, volatility will be likely to return to normal. This could create a sort of “catching up” effect between the two trading days.


Three factors should be kept in mind when going short on Friday before expiration: timing of opening the short position on Friday, moneyness of the option, and liquidity of a position.


Timing: If the underlying is relatively dormant, as you would expect on the weekend, a short position will become profitable due to losing one-third of its remaining time value. However, this all depends on when positions are opened on Friday. Selling late in the day is not desirable, because by then most short traders have already opened short positions. Selling late may create an immediate gain but selling earlier in the session places the short trader at an advantage. This explains why it occurs that selling near Friday’s close results in little or no change by Monday’s open. The best outcome is more likely by selling to open early on Friday and buying to close late on Monday. In effect, this sets up close to two trading days over a four-day span.


Moneyness: Another consideration is moneyness of the option. A short-term short position at the money is likely to gain the most, compared to other strikes. The ultra-conservative idea of selling OTM options the week before expiration is based on the rationale that time value declines but gaining intrinsic value is also difficult. However, the decline in time value is the core issue in selecting the moneyness of the option.


Liquidity: Finally, when bid and ask are exceptionally wide apart, the option is illiquid. Even the reported levels of bid and ask do not always exist in the market and are not possible to get in a trade. Most traders have experienced the frustration of delayed or unexecuted trades due to this problem. It typically happens for deep ITM options, later-expiring positions, and options on much smaller than average stocks. The “zone” for trading should be limited to those on underlying issues with healthy option activity and open interest, to maximize how expiration and time decay work out.


The observation of how the weekend effect is expected to work may be distorted by the decision to count or not count weekends in longer-term volatility analysis. For example, the CBOE’s VIX is calculated using 365 days, but most options analysts prefer limiting their studies to the 252 trading days in a year. This is a difference of about 30% in terms of the number of days used to study volatility (and time decay). The result is that the VIX tends to exaggerate market volatility because it counts weekends when volatility levels are lower than on weekdays.


The difference between calendar days and market days should not be ignored because the assumed outcomes under each method can be vastly different. Markets are typically open for 6 ½ hours each trading day but closed for 17 ½ hours. Over the weekend, the hours closed add up to 65 ½ hours. This difference in time – 17 ½ versus 65 ½ -- may explain why weekend time decay should never be overlooked as a timing factor for short trading close to expiration.


The use of weekends as part of time decay analysis is also distorted by the different timing between last trading day (Friday) and expiration day (Saturday). Should expiration Saturday be included in thew analysis, considering that trading ends the day before? Because of the difference in just which days are counted is substantial, volatility analysis and expected time decay are distorted.


Short positions might not perform as expected by traders trying to take advantage of the weekend effect. There are many reasons for the disappointment, mostly related to timing of entry and exit, moneyness, and liquidity, A simplified assumption might be that “all options lose one-third of their value between Friday and Monday before expiration,” but this is not true. Toi truly benefit from this fact of time decay selection is the key. The option should be opened and closed at maximum timing (early Friday and late Monday); it should be as close as possible to the money; and it should be a liquid position, meaning the spread between bid and ask should be as narrow as possible.

Michael C. Thomsett is a widely published author with over 80 business and investing books, including the best-selling Getting Started in Options, coming out in its 10th edition later this year. He also wrote the recently released The Mathematics of Options. Thomsett is a frequent speaker at trade shows and blogs on his website at Thomsett Publishing as well as on Seeking Alpha, LinkedIn, Twitter and Facebook.

 
Related articles

 

What Is SteadyOptions?

Full Trading Plan

Complete Portfolio Approach

Diversified Options Strategies

Exclusive Community Forum

Steady And Consistent Gains

High Quality Education

Risk Management, Portfolio Size

Performance based on real fills

Try It Free

Non-directional Options Strategies

10-15 trade Ideas Per Month

Targets 5-7% Monthly Net Return

Visit our Education Center

Recent Articles

Articles

  • The Wheel Trade

    The “wheel” trade is variously described as a beginner’s strategy, a combination to exploit features of both calls and puts, and as “perfect” solution to the well-known risks of shorting calls, even when covered. The wheel could be defined as any of these, but a larger question should be: Is the wheel an elegant method for making profits consistently, or just a gimmick?

    By Michael C. Thomsett,

    • 0 comments
    • 227 views
  • Chooser Options

    Most options traders see their world as a choice between calls or puts, alone or in various combinations. But there is more. With a chooser option, traders can open a position and decide later whether it will be a call or a put. This is also called an as you like it option.

    By Michael C. Thomsett,

    • 0 comments
    • 252 views
  • Leveraged Anchor 2020 Year In Review

    Steady Options has now been trading the Leveraged Anchor strategy for two years, and, somewhat to my surprise, 2020 went even better than 2019. On the year, Leveraged Anchor was up 31.7%, while the total return of the S&P 500 was 18.4%.

    By cwelsh,

    • 2 comments
    • 686 views
  • Ratchet Options

    The “ratchet option” is so-called because as a series, each successive position activates when the previous option has expired. The trader ratchets up (or down) to the next position. Each one is set up to be as close to the money as possible. It has many names, including cliquet, moving strike, ladder, lock-in, or reset option.

    By Michael C. Thomsett,

    • 0 comments
    • 278 views
  • Steady Momentum 2020 Year in Review

    Steady Momentum Put Write (SMPW) is one of the available subscription services at Steady Options. We launched the strategy in early 2019, so we now have two years of performance to evaluate on both an absolute basis and relative to the strategy’s benchmark, PUTW (WisdomTree CBOE S&P 500 PutWrite Strategy Fund). 

    By Jesse,

    • 0 comments
    • 259 views
  • SteadyOptions 2020 Year In Review

    2020 marks our 9th year as a public trading service. It was an excellent year for us. We closed 130 winners out of 194 trades. Our model portfolio produced 117.1% compounded gain on the whole account based on 10% allocation per trade. We had only three losing months in 2020. 

    By Kim,

    • 0 comments
    • 537 views
  • The Jump-Diffusion Pricing Formula

    One of the more complex areas of options analysis involves pricing formulas. The best known among these is the Black Scholes Model (BSM). This is a widely cited method for attempting to determine what the option’s premium should be, but it is deeply flawed.

    By Michael C. Thomsett,

    • 0 comments
    • 309 views
  • Ranges of Exotic Options

    The standard call and put are well known to all option traders, but many exotic and more advanced options can also be opened. Whether a specific broker allows trading in these, and whether a trader has the necessary trading level, are questions to be addressed. This article just defines many of the exotic options that are possible.

    By Michael C. Thomsett,

    • 0 comments
    • 406 views
  • What To Do Before Committing To Trading

    Trading cryptocurrency has become a very popular and significant part of life. While it’s not for everyone, it’s certainly for an awful lot of people. There’s money to be made and areas to be invested in, and people will do what they can to make either a quick buck or an amazing figure.

    By Kim,

    • 0 comments
    • 540 views
  • Accurate Expiration Counting

    Options traders are rightfully concerned with the number of days to expiration of an option. At the time the position is opened, whether long or short, the issue of time decay must be at the forefront of risk evaluation. But is this performed accurately?

    By Michael C. Thomsett,

    • 0 comments
    • 443 views

  Report Article

We want to hear from you!


There are no comments to display.



Create an account or sign in to comment

You need to be a member in order to leave a comment

Create an account

Sign up for a new account. It's easy and free!


Register a new account

Sign in

Already have an account? Sign in here.


Sign In Now

Options Trading Blogs Expertido