3 Options for a Short-Term SPY Trade

The secret is picking the right expiration date

   

3 Options for a Short-Term SPY Trade

The availability of options to trade has expanded tremendously over the past few decades. Not too long ago, there was just one options expiration date per month – and it was always the third Friday.

For each stock, commodity or underlying asset, we traded the first two monthly cycles, and had from two to four additional expiration cycles. Option strikes were $2.50 apart for stocks under $25, $5 apart for stocks up to $200, and $10 apart for stocks trading above $200.

Fast-forward to 2011, and now you can trade options in basically any time frame (from a few days to even a few years), and with strikes often $1 apart — even in triple-digit names.

Take the S&P 500 SPDR (NYSE:SPY) for example. It offers 16 separate expiration cycles to trade, from options expiring within a week to options expiring in January 2014. And they don’t just expire on third Fridays.

Some are weekly options, which expire every Friday. There are also quarterly options, which expire at the close of business on the last trading day of the month in March, June, September and December. And of course there are the standard monthly options, with which you may be most familiar.

Just take a look at this screenshot of SPY calls real quick (click to enlarge). You’ll see there are three currently traded expirations just in December.

Screen Shot 2011 12 05 at 9.45.57 PM 300x109 3 Options for a Short Term SPY Trade

With all the choices, how do you decide what to trade?

I’d say use the added flexibility to your advantage. Pick a time frame you’re comfortable with and roll with it.

Want to Trade Weekly Options? Here Are Some Things to Consider…

Weeklys are best suited for more active traders – at least, those who can keep a close eye on their positions — mainly because there’s just no premium cushion to mitigate a bad position.

Let’s look at the SPY, for example. The straddle (that’s when you buy to open a call and a put at the same strike price in the same expiration month, or you could instead sell to open both options) in the closest at-the-money strike in the December weeklies — $126 — trades for about $3.

(At current prices, both the $126 call and its corresponding $126 put are trading for about $1.50, so you would pay $3 to purchase both, or collect $3 to sell both.)

That sounds great, right? I mean, let’s say you sell one contract, and you’re covered from $123 to $129. (That’s $126 +/- $3.)

One problem, though — we get 2% gaps just about every other day now. So if that happens any time in the next four trading sessions (until these weeklies expire on Friday), you’re going to wake up and find that SPY has already pushed your profit potential to the brink.

You can buy it of course, but then you have risk the other way. Nothing happens, and you’re out close to the entire $3 in four trading sessions.

Either buying or selling the straddle could work spectacularly well, or prove disastrous. The point is that its a risky bet either way, particularly if you aren’t able to check in on your trade.

Standard Monthly Contracts Are Always an ‘Option’

Regular December expiration expires a week later, on that familiar third Friday. There, that same straddle goes for about $5. You would have an extra week with that trade, with the later expiration date – hence the extra premium.

Its overwhelmingly likely SPY will move a bit away in one direction (and one side of the trade becomes in-the-money) between now and then, but the now out-of-the-money leg of the trade won’t immediately go to zero, so you have a bit more cushion to play with.

In other words, if SPY moves to $123, the $126 calls with a week-plus to go will still have some value, so the straddle will not explode or implode like the weekly does.

Even so, there’s still not an enormous amount of time remaining.

My Preferred Way to Play SPY Options Right Now

Personally, I like trading options in the five- to seven-week timeframe, whether I’m a net buyer or seller. On the buying side, it gives me time for my thesis to play out (assuming I have some sort of thesis to begin with).

Right now, that brings me to regular January expiration, with just under seven weeks to go. The $126 straddle there goes for about $8.85 as I type. If I buy, it gives me some time to buy and sell SPY stock against it. If I sell, it’s not an overnight boom-or-bust bet.

Go much further in time, and a lot has to happen to move the needle on a delta-neutral options play (i.e., we’re playing with the at-the-money strikes and not establishing a directional trade). So to me, the five- to seven-week range provides the perfect sweet spot. But by all means, use the myriad time choices on the board to find what suits you best.


Article printed from InvestorPlace Media, http://investorplace.com/2011/12/3-options-for-a-short-term-spy-trade/.

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