by Mark Wolfinger | August 5, 2011 11:43 am
Weekly options, which are listed on Thursdays and expire the following Friday, are meant to offer a cost-effective way to trade around events in a specific time frame. Investors who have historically enjoyed 12 monthly expirations — the third Friday of each month — now can enjoy 52 expirations per year.
The Chicago Board Options Exchange (CBOE) offers Weeklys on more than 30 different classes including indexes (SPX, DJX, OEX, XEO), stocks (AAPL, BAC, F and others) and ETFs (SPY, IWM, GLD, QQQQ and others). See an updated list of available CBOE Weeklys here.
In the second half of 2011, the volume of the index weeklys accounted for between 9% and 11% of their underlying index volume at the time. So what is it that traders love so much about these short-term options? Keep reading to find out.
We’re not talking theoretical values here; we’re talking dollars. In general, Weeklys cost far less than monthly options simply because the time to expiration is so short. Traders only have a few days for a stock or index to move in the money.
Many unsophisticated traders don’t grasp how quickly out-of-the-money options can fade into oblivion. For these traders, Weeklys are just another way for them to lose money quickly. In the hands of more sophisticated traders who understand how to hedge their positions, Weeklys represent an additional profit opportunity.
Weekly options may not be good for conservative traders, but they are great tools for gamblers. That’s because longer-term options have a slow-changing delta because gamma is small and the option’s price does not change dramatically as the option moves from an out-of-the-money position to an in-the-money position.
With Weeklys, gamma is explosive. With so little time in the option’s life, an out-of-the-money option with a 20 delta may suddenly have an 80 delta as it moves in the money by a point or two. That results in dramatic changes in the price of the option, which can be great for speculative traders.
One other thing to note: Options buyers rejoice when their options move in the money, but option sellers lose their bet.
When a company is about to announce earnings or when the FDA is set to rule on a trial for a biotech company’s new drug, traders anticipate the likelihood of a substantial move in the stock price. Traditionally, options become very pricey prior to news because there are far more buyers than sellers. That’s true for the Weeklys also, but because these options do not rise in price as much as their longer-term counterparts (again, we are talking dollars, not implied volatility), these options are still priced at a level where the risk takers are willing to play.
And it gets even better. Once the news is released, the resulting implied volatility drop has little effect on Weeklys. With Weeklys, it’s a simple game. You win or you lose. The stock makes the move you hoped to see or it doesn’t. Your options move into the money, or become worthless (remember expiration is just a short time away). Longer-term options decrease in value due to that implied volatility drop. Thus, the stock move must be large enough to support overpaying upfront or there are no profits.
If you are a trader who carries positions with negative gamma, you get longer as the market declines and shorter as it rallies. That’s a recipe for losing money. Traders often carry such positions because they collect time decay to compensate for market risk.
Any time that risk is too high, or any time the trader requires a quick, but temporary fix, Weeklys can be bought. It’s true that these come with plenty of negative time decay, but when too much money can be lost on a big move, Weeklys, with their explosive gamma, provide excellent (temporary) insurance against that move.
The list of Weeklys available changes each week. The CBOE wants to list options that will attract a great deal of trading volume. Thus, stocks that usually have high volume are on the list. In addition, stocks that are announcing news may be included.
You can find the list of Weeklys available on the CBOE Web site. Keep in mind that no new Weeklys are listed for expiration week for standard options (the third Friday of each month). In other words, there is no need for Weeklys when the “regular” options are down to their final week.
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