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

  • SPY Short Puts vs. Put Spreads

    In this article I’ll be using the ORATS Wheel backtesting tool to compare the performance since 2007 of SPY short puts versus short put spreads. I’ll look at both risk and returns, and different ways of determining position size to adjust for the differences in risk between the two trades.

    By Jesse,

    • 0 comments
    • 414 views
  • Signs that you Are Ready to Start Investing

    If you want to build your wealth, you have to make sure that you invest your money. If you put money into a savings account and don’t earn any interest from it, this won’t work for you in the long term. Your money will lose value because of inflation, and this is the last thing that you need. So when do you invest?

    By Kim,

    • 0 comments
    • 299 views
  • One Year of Diversified leveraged Anchor

    I almost hate to keep saying it, but the Diversified Leveraged Anchor strategy keeps exceeding expectations and performing as designed. To remind our readers, Diversified Leveraged Anchor was created in April 2020 attempting to further increase performance, reduce risk, and to reduce volatility. 

    By cwelsh,

    • 5 comments
    • 867 views
  • Should I Pay Off My Mortgage Early Or Invest?

    Paying off a home mortgage early is a popular financial goal. Most people feel a level financial peace when their home is paid off that is beneficial in many ways. The most common approach to paying off the mortgage early is directly making additional principal payments to the lender on a regular basis.

    By Jesse,

    • 0 comments
    • 307 views
  • Option Order Execution Tips

    As a community of option traders, we all can relate to the occasional challenges of order execution. Best practices for avoiding errors as well as techniques for better potential execution will be the focus of this article.  Like countless others in the Steady Options community, I personally have traded thousands of option contracts over the last decade.

    By Jesse,

    • 17 comments
    • 1,508 views
  • What Trading Can Offer To A Newcomer

    For any first-time investor, one of the most important questions to ask is “why are you doing this?”. Getting into investment can be thrilling and open up new worlds for you, but it can also be draining both physically and emotionally, with long days and sudden market moves always a genuine risk.

    By Kim,

    • 0 comments
    • 462 views
  • Updated: The Performance Gap Between Large Growth and Small Value Stocks

    Eight months ago on July 21st 2020 I posted an article, The Performance Gap Between Large Growth and Small Value Stocks. Over the long-term small cap value stocks have outperformed large cap growth stocks, although not over more recent history.

    By Jesse,

    • 0 comments
    • 718 views
  • 6 Ways to Invest Your Money That Aren't Cash Savings

    It’s always a good idea to keep some of your money in cash so if there is an emergency and you need money in a hurry, you can access it without having to worry. However, cash savings are not your only option if you have money left over at the end of the month, and there are a lot of other options that could bring greater returns.

    By Kim,

    • 0 comments
    • 674 views
  • Jade Lizard Options

    The jade lizard is one of those bullish spreads with limited maximum profit, and no risk on the upside. It is a combination of a short put with a short call spread . The credit this creates is higher than the span of the spread. To set this up, two actions are required:

    By Michael C. Thomsett,

    • 0 comments
    • 1,079 views
  • Are Your Emotions Trying To Tell You Something?

    As a trader, you may find yourself frequently trying to ignore or rationalize emotions.  You may have even created your own “solutions” to manage them. You exit early to lock up profit and avoid a potential blow-up if the trade turns against you.

    By Jared Tendler,

    • 0 comments
    • 681 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