Interest in weekly options has boomed since they were introduced just six years ago. In fact, in the last half of 2010, index weekly option volume amounted to between 5%-7% of underlying index volume.
In a volatile market, which you may have noticed is currently the case, the shorter expiration time frame allows traders to profit from the kind of quick moves in stocks and exchange-traded funds that the market is now producing.
The approach of expiration brings on interesting dynamics regarding an option’s behavior. Many option sellers champion short-term options as the ever-rising theta offers promises of quicker profits due to time decay. Indeed, this is the allure of weekly options.
However, there is a drawback often conveniently glossed over: Just as naughty children become increasingly rowdy as the school day nears its end, options become increasingly unstable as expiration approaches. This is due to fact that gamma, an option’s rate of change with respect to being in or out of the money, also escalates heading into expiration. This often causes dramatic fluctuations in price. The fact that you can capture profits or incur losses rapidly makes them a tool more appropriate for speculative traders.
One effective use of weekly options for more conservative traders looking to hedge event risk is to treat them as inexpensive insurance policies. Suppose you own 100 shares of Apple (NASDAQ:AAPL) and are looking to acquire some type of protection heading into its earnings announcement. Rather than purchasing a one- or two-month put option just before the announcement, you may consider snatching up a weekly put that will be priced much cheaper. Keep this in mind when next earnings season rolls around in October.
GLD, SLV, BAC Weekly Options – How to Profit Next Week
Buy BAC Puts
Recommended by: Chris Johnson and Jon Lewis, Editors, The Winning Edge
One prominent name among the financials is Bank of America (NYSE:BAC), which has been rocked by bad mortgage debt hanging like an albatross around its balance sheet. The stock tumbled nearly 60% from its February high to last week’s lows, and the shares have lagged the overall sector throughout most of 2011.
After rallying more than 20% off last week’s low, the shares were rejected by the declining 10-day moving average. Thursday’s drop pushed the stock back down toward the previous low. But there still is about 10% of downside room before reaching the bottom (assuming that there really is a bottom).
Sentiment toward BAC is surprisingly mixed. Short interest is negligible and 18 of 32 analysts still consider the stock a buy (it’s anyone’s guess as to why). We see plenty of downside ahead for BAC over the next week given the technical rejection, the market’s sour mood, the floundering global economy, and the misplaced optimism directed toward the shares. Buy the Aug. 26 7 Puts for 50 cents or less.
Buy SLV Puts
Recommended by: John Jagerson, Options Coach, Turbo Trader Live
On Thursday, sellers emerged with a vengeance following some poor economic announcements. During periods like this, many asset classes can get very correlated and it is tough to find the standout opportunity. However, we noticed an interesting trading pattern on the iShares Silver Trust (NYSE:SLV) ETF that we had been hoping would emerge.
SLV is torn between two worlds. On the one hand, silver as a commodity is often considered a safe haven (like gold) and will rise in value when uncertainty spikes. However, silver’s primary use is as an industrial metal like steel or copper, so demand for commodities in general can overwhelm its attractiveness as a safe haven.
Because SLV didn’t respond to the demand for safe-haven investments on Thursday, and has stalled at resistance we think commodity sellers are in control. We recommend buying the Aug. 26 38 Puts on SLV for 50 cents a share or less. There is some very strong volume on this chain sheet, and if SLV drops down from resistance and heads toward support at $35 like we think it will, the gains would be impressive.
Next: How to Play GLD
Bullish Call Spread on GLD
Recommended by: Dan Passarelli, Market Taker
When accessing weekly option plays, a lot of traders instantly think about some type of a credit spread. Why? Because with one week left to expiration, theta will be relatively on the high side, meaning time decay will reduce the option’s premium at a faster and faster rate as expiration approaches. The problem with credit spreads is that a trader typically risks more than the initial credit.
A more conservative approach might be to implement a vertical debit spread, such as a bull call spread. A debit spread is one in which the trader pays more premium for the long options than the short options. Option traders tend to forget that debit spreads still take advantage of some time decay because of the short option’s time decay will help offset the long option’s loss of time value. Debit spreads usually risk less than credit spreads and typically have a higher reward, which gives debit spreads an advantage at least when talking about profit potential.
A bull call spread involves buying a call option and selling a higher strike call option against it. The cost of buying the lower strike call option is somewhat offset by the premium received from the higher strike that was sold. The maximum gain on this spread is the difference in the strike prices minus the cost of the trade.
The option trader will realize the maximum gain if the price of the stock is higher than the strike that was sold at expiration. The most the option trader can lose is the cost of the spread. This maximum loss will occur if the stock is trading below the call that was bought at expiration.
An advantage of using weekly options for a vertical debit spread such as the bull call spread is that maximum profit can be realized in a very short period of time because expiration is so close. The disadvantage to a short period of time is so can maximum loss.
Let’s look at an example this week:
With the market continuing to struggle, gold looks like a decent bet to continue to go higher, especially in the near future. People and traders seem to flock to precious metals when the market and economy is in turmoil. The SPDR Gold Shares (NYSE:GLD) exchange-traded fund could possibly continue its ascent even higher through next week.
GLD is currently trading around $180.
The Trade: Buy Aug.26-2011 181/183 Bull Call Spread
Cost of the trade: Buy Aug26 181 call – $2.50 debit
Sell Aug26 183 call – $1.75 credit
$0.75 debit ($2.50 – $1.75)
$75 would be lost if GLD finished under $181 at Aug. 26 expiration.
Maximum profit of the trade: Difference in the strike prices minus the cost of the trade.
$1.25 credit ((183 – 181) -$0.75)
$125 would be made be made if GLD finished above $183 at Aug26 expiration.
Every trade should have defined risk and loss parameters in place.
