Options Greeks: Theta, Delta, Vega, Gamma
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By Mark Wolfinger
Questions:
Do options ever become so expensive that it is no longer worthwhile to pay the high asking price to buy them? We may know that a news announcement is pending, but so do other investors —and they also want to buy options. Translation: Increased demand results in a significant increase in option prices and implied volatility. How can we determine whether a point has been reached such that we have a better opportunity to earn money by switching to negative-gamma (i.e., the opposite of our traditional) strategies?
For this discussion, let’s consider premium-buying strategies are limited to market neutral strategies like buying long straddles and strangles, buying single options, and trading reverse iron condors where you buy the call and put spreads, paying a cash debit to own the position
Similarly, the premium-selling strategies are limited to market neutral strategies like selling straddles, strangles and single options. Also the traditional iron condor (sell both the call and put spreads and collect a cash credit).
Answers:
It should be intuitively obvious that there has to be some price at which it no longer pays to buy options to own positive positive gamma. [For an extreme example, I hope that you would never pay $8 for a pre-earnings, ATM straddle on a non-volatile, $20 stock.] Thus, as intelligent traders, we are limited and cannot adopt our favorite strategies every time there is an earnings announcement pending. Due diligence is required, and that includes analyzing a substantial amount of historical data so that we can estimate what may happen in the future by looking at what occurred in the past. Such data includes:
Previous post-news price gaps. We want to know the largest and smallest (based on a percentage of the stock price) and the median gaps when this specific stock announced earnings results. We do not need results from the last 20 years because stock markets change over time and more recent history is far more important. I suggest using 3 to 4 years of data (12 to 16 news announcements). Why is this information so important?
The data provides a good estimate of how much you can afford to pay for the options. There are two ways to profit.
First, exit the trade whenever there is a satisfactory profit before news is released.
When implied volatility increases by enough, your position increases in value and it may be attractive to unload the position and lock in the gains prior to the news release.
When the stock makes a big move prior to the news release, the positive-gamma position will be worth far more than you paid for it —and that may be a profit worth taking.
Second, when we do wait for the news release, the profitability of the trade depends on the size of the price gap and the cost of the options.
By looking at past data, we have a reasonable estimate for the size of any future price gap and thus, the value of our option position. Obviously this is just an estimate and the current trade may perform much better or much worse than the average. But, it is that average that dictates just how much we should pay for our option position. If the ATM straddle is worth $6 (on average) immediately after the market opens after the announcement, then we should not be willing to pay as much as $6 to buy the straddle.
The average implied volatility must be considered. If the IV averages 34 for the time slot (i.e., number of days in advance of news), in which we buy the options then we cannot expect to earn a profit when paying 40.
The cost (IV) of buying the pre-news options at a variety of times. It is important to discover a good time to buy the options (i.e., before IV has risen too far in anticipation of the pending news).
The price history for the stock, in the days leading up to the news release: How often did the stock rally/fall enough to generate a good profit without bothering to hold until the earnings news is released? If this never happens for a given stock, then the price that we can pay for a the straddle decreases because one of our profit opportunities is not present.
Results. How would various gamma-buying strategies have performed in the past? This requires examining option-pricing data as well as the stock price.
There is a lot of data that a trader may analyze.
The work produces guidelines for making trades, and we depend on those guidelines to tell us when to enter, and when to avoid, using our methods.
The second question is more difficult to answer because so much depends on the individual trader. For example, some traders will never sell straddles or strangles because risk is too high. Others understand how to manage risk for such trades (most important is choosing proper position size) and would adopt the negative-gamma strategies when the option prices are so high that it is reasonable to anticipate earning a profit by selling them.
Be careful. If you decide that paying $9 for a straddle (or paying a 34 implied volatility) is too high to buy the options that does not suggest that it is okay to sell. Selling requires a decent edge. For example, if your maximum bid for a straddle is $6 (reminder: the average post-news straddle is worth $9), I would not want to consider selling that same straddle unless I could collect $12 (or an IV of at least 40). Those numbers describe my personal guidelines and you must choose your own.
There is a lot of work to do before investing your money into option trades. Fortunately SteadyOptions does the tedious analysis and we can trade their suggestions. There is no guarantee of success. However, it is always good to trade with the probabilities on your side — and that is what you get with your SO membership.
Related articles:
Options Trading Greeks: Gamma For Speed Why You Should Not Ignore Negative Gamma
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Mark Wolfinger has been in the options business since 1977, when he began his career as a floor trader at the Chicago Board Options Exchange (CBOE). Since leaving the Exchange, Mark has been giving trading seminars as well as providing individual mentoring via telephone, email and his premium Options For Rookies blog. Mark has published four books about options. His Options For Rookies book is a classic primer and a must read for every options trader. Mark holds a BS from Brooklyn College and a PhD in chemistry from Northwestern University.
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By Kim
The Delta is one of the most important Options Greeks.
General
The delta of an option is the sensitivity of an option price relative to changes in the price of the underlying asset. It tells option traders how fast the price of the option will change as the underlying stock/future moves.
Option delta is usually displayed as a decimal value between -1 and +1. Some traders refer to the delta as a whole number between -100 and +100. Delta of +0.50 is the same as +50.
The following graph illustrates the behaviour of both call and put option deltas as they shift from being out-of-the-money (OTM) to at-the-money (ATM) and finally in-the-money (ITM). Note that calls and puts have opposite deltas - call options are positive and put options are negative.
Call and Put Options
Whenever you are long a call option, your delta will always be a positive number between 0 and 1. When the underlying stock or futures contract increases in price, the value of your call option will also increase by the call options delta value. When the underlying market price decreases the value of your call option will also decrease by the amount of the delta. When the call option is deep in-the-money and has a delta of 1, then the call will move point for point in the same direction as movements in the underlying asset.
Put options have negative deltas, which will range between -1 and 0. When the underlying market price increases the value of your put option will decreases by the amount of the delta value. When the price of the underlying asset decreases, the value of the put option will increase by the amount of the delta value. When the underlying price rallies, the price of the option will decrease by delta amount and the put delta will therefore increase (move from a negative to zero) as the option moves further out-of-the-money. When the put option is deep in-the-money and has a delta of -1, then the put will move point for point in the same direction as movements in the underlying asset.
If you have a call and a put option, both for the same underlying, with the same strike price, and the same time to expiration, the sum of absolute values of their deltas is 1.00. For example, you can have an out of the money call with a delta of 0.36 and an in the money put with a delta of -0.64.
Delta Sensitivity
As a general rule, in-the-money options will move more than out-of-the-money options, and short-term options will react more than longer-term options to the same price change in the stock.
As expiration nears, the delta for in-the-money calls will approach 1, reflecting a one-to-one reaction to price changes in the stock. Delta for out-of the-money calls will approach 0 and won’t react at all to price changes in the stock. That’s because if they are held until expiration, calls will either be exercised and “become stock” or they will expire worthless and become nothing at all.
As expiration approaches, the delta for in-the-money puts will approach -1 and delta for out-of-the-money puts will approach 0. That’s because if puts are held until expiration, the owner will either exercise the options and sell stock or the put will expire worthless.
As an option gets further in-the-money, the probability it will be in-the-money at expiration increases as well. So the option’s delta will increase. As an option gets further out-of-the-money, the probability it will be in-the-money at expiration decreases. So the option’s delta will decrease.
It is important to remember that Delta is constantly changing during market hours and will typically not accurately predict the exact change in an option’s premium.
Delta as Probability
Delta can be viewed as a percentage probability an option will wind up in-the-money at expiration. Therefore, an at-the-money option would have a .50 Delta or 50% chance of being in-the-money at expiration. Deep-in-the-money options will have a much larger Delta or much higher probability of expiring in-the-money.
Looking at the Delta of a far-out-of-the-money option is a good indication of its likelihood of having value at expiration. An option with less than a .10 Delta (or less than 10% probability of being in-the-money) is not viewed as very likely to be in-the-money at any point and will need a strong move from the underlying to have value at expiration.
As mentioned, the sum of absolute values of delta of a call and a put with the same strike is one. This is in line with the probability idea. When you have a call and a put on the same underlying and with the same strike price, you can be sure that one of them will expire in the money and the other will expire out of the money (unless, of course, the underlying stock ends up exactly equal to the strike price and both options expire exactly at the money). Therefore, the sum of the probabilities should be 100% (and the sum of the absolute values of deltas should be one).
Just for clarification, delta and probability of expiring in the money are not the same thing. Delta is usually a close enough approximation to the probability.
Example
If the delta on a particular call option is .55, then, all other things being equal, the price of the option will rise $0.55 for every $1 rise in the price of the underlying security. The opposite effect is also seen as for every $1 decline in the price of the underlying the option will lose $0.55.
If the delta on a particular put option is -.45, then, all other things being equal, the price of the option will rise $0.45 for every $1 fall in the price of the underlying security. As with call options the obverse scenario is also true.
List of delta positive strategies
Long Call Short Put Call Debit Spread Put Credit Spread Covered Call Write
List of delta negative strategies
Long Put Short Call Put Debit Spread Call Credit Spread Covered Put Write
List of delta neutral strategies
Iron Condor Butterfly Short Straddle Short Strangle Long Straddle Long Strangle Long Calendar Spread
Summary
Positions with positive delta increase in value if the underlying goes up Positions with negative delta increase in value if the underlying goes down An option contract with a delta of 0.50 is theoretically equivalent to holding 50 shares of stock 100 shares of stock is theoretically equivalent to an option contract with a 1.00 delta
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Related articles:
The Options Greeks: Is It Greek To You? Options Trading Greeks: Theta For Time Decay Options Trading Greeks: Vega For Volatility Options Trading Greeks: Gamma For Speed
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By Kim
The Gamma is one of the most important Options Greeks.
It generally is at its peak value when the stock price is near the strike of the option and decreases as the option goes deeper into or out of the money. Options that are very deeply into or out of the money have gamma values close to 0.
Effect of volatility and time to expiration on gamma
Gamma is important because it shows us how fast our position delta will change as the market price of the underlying asset changes.
When volatility is low, the gamma of At-The-Money options is high while the gamma for deeply into or out-of-the-money options approaches 0. The reason is that when volatility is low, the time value of such options are low but it goes up dramatically as the underlying stock price approaches the strike price.
When volatility is high, gamma tends to be stable across all strike prices. This is due to the fact that when volatility is high, the time value of deeply in/out-of-the-money options are already quite substantial. Thus, the increase in the time value of these options as they go nearer the money will be less dramatic and hence the low and stable gamma.
As the time to expiration draws nearer, the gamma of At-The-Money options increases while the gamma of In-The-Money and Out-of-The-Money options decreases.
How to put gamma work for you
In simple terms, the gamma is the option's sensitivity to changes in the underlying price. In other words, the higher the gamma, the more sensitive the options price is to the changes in the underlying price.
When you buy options, the trade has a positive gamma - the gamma is your friend. When you sell options, the trade has a negative gamma - the gamma is your enemy. The closer we are to expiration, the higher is the gamma.
When you buy options and expect a significant and quick move, you should go with closer expiration. The options with closer expiration will gain more if the underlying moves. The tradeoff is that if the underlying doesn't move, the negative theta will start to kick off much faster.
When you sell options, you have negative gamma that will increase significantly as the options approach expiration. This is the biggest risk of selling weekly options.
Should you trade weekly options?
Selling options with closer expiration will give you higher positive theta per day but higher negative gamma. That means that a sharp move of the underlying will cause much higher loss. So if the underlying doesn't move, then theta will kick off and you will just earn money with every passing day. But if it does move, the loss will become very large very quickly. Another disadvantage of close expiration is that in order to get decent credit, you will have to choose strikes much closer to the underlying.
As we know, there are no free lunches in the stock market. Everything comes with a price. When the markets don't move, trading close expiration might seem like a genius move. The markets will look like an ATM machine for few weeks or even months. But when a big move comes, it will wipe out months of gains. If the markets gap, there is nothing you can do to prevent a large loss.
Does it mean you should not trade weekly options? Not at all. They can still bring nice gains and diversification to your options portfolio. But you should treat them as speculative trades, and allocate the funds accordingly. Many options "gurus" describe those weekly trades as "conservative" strategy. Nothing can be further from the truth.
Example
Lets sat you have a call with a delta of .60. If the price of the underlying security rises by $1, then the price of the call would therefore rise by $.60. If the gamma value was .10, then the delta would increase to .70. This means that another $1 rise in the price of the underlying security would result in the price of the option increasing by $.70, and the delta would also increase again in accordance with the gamma.
This highlights how moneyness affects the delta value of an options contract, because when the contract gets deeper into the money, each price movement of the underlying security has a bigger effect on the price. The gamma is also affected by moneyness, and it decreases as an in the money contract moves further into the money.
This means that as a contract gets deeper into the money, the delta continues to increase but at a slower rate. The gamma of an out of the money contract would also decrease as it moved further out of the money. Therefore, gamma is typically at its highest for options that are at the money, or very near the money.
List of gamma positive strategies
Long Call Long Put Long Straddle Long Strangle Vertical Debit Spread
List of gamma negative strategies
Short Call Short Put Short Straddle Short Strangle Vertical Credit Spread Covered Call Write Covered Put Write Iron Condor Butterfly Long Calendar Spread
Summary
Gamma measures the rate of change for delta with respect to the underlying asset's price. All long options have positive gamma and all short options have negative gamma. The gamma of a position tells us how much a $1.00 move in the underlying will change an option’s delta. We never hold our trades till expiration to avoid increased gamma risk.
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Related articles:
The Options Greeks: Is It Greek To You? Options Trading Greeks: Theta For Time Decay Options Trading Greeks: Delta For Direction Options Trading Greeks: Vega For Volatility Why You Should Not Ignore Negative Gamma Short Gamma Vs. Long Gamma
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By Kim
In other words, an option premium that is not intrinsic value will decline at an increasing rate as expiration nears.
The Theta is one of the most important Options Greeks.
Negative theta vs. positive theta
Theta values are negative in long option positions and positive in short option positions. Initially, out of the money options have a faster rate of theta decay than at the money options, but as expiration nears, the rate of theta option time decay for OTM options slows and the ATM options begin to experience theta decay at a faster rate. This is a function of theta being a much smaller component of an OTM option's price, the closer the option is to expiring.
Theta is often called a "silent killer" of option buyers. Buyers, by definition, have only limited risk in their strategies together with the potential for unlimited gains. While this might look good on paper, in practice it often turns out to be death by a thousand cuts.
In other words, it is true you can only lose what you pay for an option. It is also true that there is no limit to how many times you can lose. And as any lottery player knows well, a little money spent each week can add up after not hitting the jackpot for a long time. For option buyers, therefore, the pain of slowly eroding your trading capital sours the experience.
When buying options, you can reduce the risk of negative theta by buying options with longer expiration. The tradeoff is smaller positive gamma, which means that the gains will be smaller if the stock moves.
Option sellers use theta to their advantage, collecting time decay every day. The same is true of credit spreads, which are really selling strategies. Calendar spreads involve buying a longer-dated option and selling a nearer-dated option, taking advantage of the fact that options expire faster as they approach expiration.
You can see the accelerated curve of option time decay in the following graph:
As a general rule of thumb, option sellers want the underlying to stay stable, while option buyers want it to move.
List of positive theta options strategies
Short Call Short Put Short Straddle Short Strangle Covered Call Write Covered Put Write Long Calendar Spread Vertical Credit Spread Iron Condor Butterfly Spread List of negative theta options strategies
Long Call Long Put Long Straddle Long Strangle Vertical Debit Spread
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Related articles:
The Options Greeks: Is It Greek To You? Options Trading Greeks: Vega For Volatility Options Trading Greeks: Delta For Direction Options Trading Greeks: Gamma For Speed
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By Kim
Introduction
In November of 2012, CBOE and C2 issued Information Circulars IC12-093 and IC12-015 announcing the expansion of the number of Weeklys that can be listed for certain securities. CBOE and C2 may now list up to five consecutive Weeklys in a class provided that an expiration does not coincide with one that already exists.
According to CBOE, "Weeklys were established to provide expiration opportunities every week, affording investors the ability to implement more targeted buying, selling and spreading strategies. Specifically, Weeklys may help investors to more efficiently take advantage of major market events, such as earnings, government reports and Fed announcements."
Not every stock or index has weekly options. For those that do, it basically means that every Friday is an expiration Friday. That opens tremendous new opportunities but also introduces new risks which can be much higher than "traditional" monthly options.
Basically, just about any strategy you do with the longer dated options, you can do with weekly options, except now you can do it four times each month.
Let's see for example how you could trade SPY using weekly or monthly options.
Are they cheap? Lets buy them
SPY is traded around $218 last Friday Aug. 19, 2016. Looking at ATM (At The Money) options, we can see that Sep. 16 (monthly) calls can be purchased at $2.20. That would require the stock to close above $220.20 by Sep. 16 just to break even. However, the weekly options (expiring on August 26, 2016) can be purchased at $1.08. This is 50% cheaper and requires much smaller move.
However, there is a catch. First, you give yourself much less time for your thesis to work out. Second and more importantly, the weekly options are much more exposed to the time decay (the negative theta).
The theta is a measurement of the option's time decay. The theta measures the rate at which options lose their value, specifically the time value, as the expiration draws nearer. Generally expressed as a negative number, the theta of an option reflects the amount by which the option's value will decrease every day. When you buy options, the theta is your enemy. When you sell them, the theta is your friend.
For the monthly 218 calls, the negative theta is -$4.00. That means that the calls will lose ~1.8% of their value every day all other factors equal. For the weekly calls, the negative theta is a whopping -$7.70 or 7.1% per day. And that number will accelerate as we get closer to the expiration day. You better be right, and you better be right quickly.
Buying is too risky? Maybe selling is better?
If this is the case you might say - why not to take the other side of the trade? Why not to use the accelerating theta and sell those options? Or maybe be less risky and sell a credit spread? A credit spread is when you sell an option and buy another option which is further from the underlying price to hedge the risk.
Many options "gurus" ride the wave of the weekly options trading and describe selling of weekly options as a cash machine. They say that "It brings money into my clients account weekly. Every Sunday my clients access their accounts and see + + +.” They advise selling weekly credit spreads and present it as a "a safe option strategy because we’re combining an option purchase with an option sale resulting with a credit into your account".
This short term option trading strategy can work very well... until it doesn't.
Imagine for example someone selling a 206/205 put credit spread on Thursday June 23, 2016 with SPY around $210.80. That seems like a pretty safe trade, isn't it? After all, we have just one day, what could possibly go wrong? The options will probably expire worthless and the clients will see more cash in their account by Sunday. Well, after the market close, news about Brexit took traders by surprise. The next day SPY opened below $204 and the credit spread has lost almost 100%. So much for the "safe strategy".
Of course this example of weekly options trading risks is a bit extreme, but you get the idea. Those are very aggressive trades that can go against you very quickly.
Be Aware of the Negative Gamma
So what is the biggest problem with selling the weekly options? The answer is the negative gamma.
Condor Evolution. Source: http://tylerstrading.blogspot.ca/2010/09/condor-evolution.html
The gamma is a measure of the rate of change of its delta. The gamma of an option is expressed as a percentage and reflects the change in the delta in response to a one point movement of the underlying stock price. When you buy options, the gamma is your friend. When you sell them, the gamma is your enemy.
When you are short weekly options (or any options which expire in a short period of time), you have a large negative gamma. Any sharp move in the underlying will cause significant losses, and there is nothing you can do about it.
Here are some mistakes that people make when trading Iron Condors and/or credit spreads:
Opening the trade too close to expiration. There is nothing wrong with trading weekly Iron Condors - as long as you understand the risks and handle those trades as semi-speculative trades with very small allocation. Holding the trade till expiration. The gamma risk is just too high. Allocating too much capital to Iron Condors. Trying to leg in to the trade by timing the market. It might work for some time, but if the market goes against you, the loss can be brutal and there is no another side of the condor to offset the loss.
The Bottom Line
So is the conclusion that you should not trade the weekly options? Not necessarily. Short term option trading can be a good addition to a diversified options portfolio - as long as you are aware of the risks and allocate only small portion of the account to those trades.
Just remember that those options are aggressive enough to create quick profits or quick losses, depending on how you use them.
Related articles:
The Options Greeks: Is It Greek To You? The Risks Of Weekly Credit Spreads Options Trading Greeks: Gamma For Speed Options Trading Greeks: Theta For Time Decay Why You Should Not Ignore Negative Gamma Make 10% Per Week With Weeklys?
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By Mark Wolfinger
This trader is short two put spreads. One in YHOO (Jul 23/24) and the other in RUT (Jul 920/925). These positions began as iron condors and the calls were covered at a cheap price. "I’m not sure of what I should do. When adding these two positions together, the ‘portfolio’ is too delta long for my comfort zone."
=== RUT ===
I could offset the positive delta of the put-spread by shorting another call-spread. But that is somewhat inconsistent with my belief that I should initiate positions with at least two-months expiry. What would be more consistent is if I closed the put-spread and opened another Iron-Condor with a later expiry. The only thing is that in order to exit at break-even… This is somewhat expected as the volatility conditions for this trade were less than favorable.
Another option would be to roll-down the put-spread. This would reduce the amount of positive-delta, but still leave the portfolio with positive delta. I guess I will be looking to exit the RUT put-spread today. [Note: Position was closed @ 1.20]
My response:
Be careful about measuring portfolio delta. One RUT deltas is much more significant than one YHOO.
a) Delta is the change in value for an option when the underlying moves ONE POINT. One point for YHOO is a big move. One point for RUT is insignificant.
b) The YHOO spread is only one point wide and the max price for the spread is $100
c) The RUT spread is 5 points wide and the max loss is $500 (less credit collected)
d) Delta is a good guide for current (imminent risk), and the risk graph shows how bad things can get when such and such happens. But as to your comfort zone, the RUT position is far more ‘dangerous’ because more cash is at risk and RUT will move many more points than YHOO on almost every trading day.
e) Also consider that RUT is 40 points OTM. I am not suggesting that this is ‘safe’ but the question is: how do you feel about it? If this makes you nervous, yes, do exit. Especially today with a small market bump and a small IV decrease (RVX is -.77 as I write this).
Adjustments
Yes, selling another call spread is a viable adjustment. It is one way to maintain delta neutrality. However, when a trader looks at the current market, it is very difficult to sell call spread now that the DJIA has declined by more than 500 points in the past two days. The ‘best’ time to sell that call spread is immediately after covering your previous short spread. But selling another call spread is not for everyone. This is a difficult decision and I cannot offer guidance. For my trading, I do occasionally sell another spread after covering, but most of the time I do as you did: nothing.
There is a world of difference between initiating positions and adjusting positions.
When initiating a new trade, you have the ability to wait until conditions suit your needs. There is no urgency. You can easily satisfy that need for a minimum of two months.
Adjusting requires a very different mindset. Your objective when adjusting is to reduce risk. NOW. It is not to make more money from the trade. It has nothing to do with future profits. It is only about one thing: recognizing that this trade has gone awry and you want to give yourself the best opportunity to stop the bleeding. Primary goal: make the position less risky, reducing the immediate cash at risk. Secondary goal: Create a position that you want to own (do not blindly adjust and hope for the best) and which gives you a good (this is where your judgement comes into play) chance to make money from THIS POINT. Do not worry about past losses. Do not trade to recover those losses. Trading to get back to even is a losing mindset. Traders make plenty of poor decisions trying to recover losses.
Closing the put spread and opening another iron condor is a good idea. But ONLY when
You do not allow the idea of ‘break even’ to be part of the decision. Please take my word for this. I know what it is like to roll the old position into a new one, choosing the new position based on its price (in other words, paying zero debit or collecting a cash credit for the roll), giving myself the chance to earn my original profit target – if only the new spread would expire worthless. When the market is trending this style of trading is financial suicide. Be willing to take the loss and independently find a suitable new position.
You want to exit the current position because it is not one you want to own.
The new iron condor is one that fits your trading criteria. Far too often traders make this ‘roll’ just to do something. Do not fall into that trap.
You understand that doing this is two separate decisions. Close when you believe that is best. Open a new trade when you find a good one. Do not feel you must open that new trade at the same time the old one is closed. Yes – I know the need to get a new position so you can recover losses. Nothing wrong with wanting that new trade. Just make it a good one and do not allow the thought of getting back your money be part of the decision process. Yes, rolling down the put spread is viable, when two conditions are met.
The cash debit required is not more than you are willing to pay The new position is one that you want to own. The important point of this post is that one YHOO delta is not the same as one RUT delta.
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By Jacob Mintz
This leads me to believe the market may be stuck in no-man’s land.
And third, we are coming up on a double whammy for options prices. Here is what I mean by that:
As I have written in the past, options prices get hit hard as one expiration cycle expires and a new options expiration becomes the front month. And this week, January options will cease to exist, and February options will be the front month.
The reason for this? Let’s say you were long stock in Facebook (FB) and short a January call against it. This is the typical buy-write/covered call position. As the January call you are short expires you would look to sell a new call against your FB stock position.
However, Jacob the market maker knows that this trade is coming from individual traders and from institutions. So, as the market maker, I would start lowering the price of the February options ahead of time so that I will be buying at a cheaper price when others are selling.
Then, on top of that throw in the upcoming long weekend.
The stock market will be closed on Monday, January 21st for Martin Luther King Day—a nice three-day weekend. But it’s not generally good for options prices.
Over the course of the next couple of days, the market makers, or more likely their computer systems, are going to “push the date ahead” in all their products. So in the market makers’ pricing models, tomorrow’s date won’t be January 17th, it’s more likely to be January 21st.
And as we get closer to this weekend, the computer models will move the date to January 22nd, which is the day the market opens after the holiday. The models do this to price in the decay of the day off for the holiday. That means that they will take virtually all of the decay out of the options ahead of time so that they aren’t stuck being the buyer of decaying assets over a long weekend.
So how do we profit from this phenomenon? By selling options via buy-writes or option spreads like an Iron Condor.
Here is the breakdown of a short volatility trade known as an Iron Condor which could work well ahead of a long holiday weekend:
The Iron Condor position is the combination of a bear call spread and a bull put spread in the same underlying.
It’s a strategy that’s a high probability trade, allowing for a modest profit with enough room for error. Also, it’s meant to be a directionally neutral trade, used when volatility is elevated in relation to its forecasted range.
It’s my favorite volatility selling strategy. By selling a call spread and a put spread, you gain extra short volatility and decay, while at the same time limiting your risk.
Here’s the hypothetical call spread:
Stock XYZ is trading at 90. You’d theoretically sell the 100/105 bear call spread for $1. To execute this trade, you would:
Sell the 100 calls Buy the 105 calls For a total credit of $1.
Here is the graph of this trade at expiration.
Here’s the hypothetical put spread:
Stock XYZ is trading at 90. You’d sell the 85/80 put spread for $1. To execute this trade you would:
Sell the 85 Puts Buy the 80 Puts For a total credit of $1.
Here is the graph of this trade at expiration:
Now we will combine these two spreads to make an Iron Condor:
To do this, you simultaneously:
Sell the 100 calls Buy the 105 calls For a total credit of $1.
And
Sell the 85 Puts Buy the 80 Puts For a total credit of $1.
This would give you a total credit of $2.
Here is the graph of this trade at expiration:
As you can see in the chart, at expiration, you’d make $2 as long as the stock stays between 85 and 100. Meanwhile, your downside is limited to $3 if the stock goes lower than 80 or higher than 105.
To learn more about these strategies and Cabot Options Trader where I use these strategies to create profits in any market visit Jacob Mintz or optionsace.com where I teach and mentor options traders.
Your guide to successful options trading,
Jacob Mintz
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