Get Key Signals from Weekly Options

12/27/2011 10:56 am EST

Focus: OPTIONS

Dan Passarelli

Founder, Market Taker Mentoring, LLC

Even those who don’t trade weekly options should at least examine weekly option open interest for valuable supply and demand signals on the underlying stock or ETF.

Options have traditionally traded in 12 cycles per year. Since there are 52 weeks per year, most monthly cycles have had a life span of four weeks with the occasional five-week cycle in order to make the math work out. In these multi-week cycles, each week tends to have its own personality and the tempo of price change would often accelerate as expiration approached. 

This effect was at least in part the result of the non-linear nature of the decay curve of extrinsic premium. It is as if the option cycle began with a decay curve akin to an easy, green ski trail and ends on a double-black-diamond slope.

For strategies that include a component of being short premium, the maximum potential total profit or loss is only achieved at expiration. This effect is easily seen in the case of vertical spreads, which only reach their maximum potential gain or loss at expiration or when the spread goes deep in or out of the money.

CBOE introduced weekly options in 2005 on several broad indices, and the launch was met with a tepid reception. However, trading volume in weekly options contracts has recently exploded, additional indices and underlying ETFs have been added, and a number of actively traded equities have joined the family of weekly options. An updated list of the rapidly increasing available weeklies can be found at this CBOE Web site.

See related: 4 Tips for Trading Weekly Options

Weekly options are a rapidly evolving and changing part of the options world. As an example of this rapid evolution, the new week’s options have begun to be offered on the Thursday of the week prior to expiration, rather than the Friday, as had been the case previously effective July 1, 2010.

The availability of weekly options has undoubtedly had a significant impact on a variety of strategies.  Their acceptance and increase in trading volume has been nothing short of stunning. For example, the 390 and 395 call strikes in AAPL that expired December 23 each have an open interest of around 10,000 contracts on December 22, the day before expiration!

Even if you don’t trade weekly options, you should at least take a look at them prior to placing your standard option trade just to get a feel for the supply and demand of the underlying stock or ETF.

By Dan Passarelli of MarketTaker.com

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