The Worst Day to Sell Option Premium

03/03/2012 6:00 am EST


Mark Sebastian

Founder, Option Pit LLC

Former market maker Mark Sebastian explains that, by Friday, there is almost no point in selling option premium, because the entire weekend is priced out of options ahead of the weekend.

Several weeks ago, I was mentoring a student on a Monday. This student had a calendar spread on that was going very well. On a certain Friday, his calendar position was up about 18%. This student then opened his options analysis tool and moved his days forward from Friday afternoon to Monday morning. He was really excited because if he could just hold on through the weekend, he was going to collect another 4% return on his capital.

The following Monday when I met with him, he was quite despondent. He had held his position over the entire weekend, and after the market movement that Monday morning, he was actually down money from Friday!

He said to me, “Mark, I don’t get it, I did my analysis! I should be up at least a few hundred dollars from last Friday! How come I didn’t make anything over the weekend?”

See related: The Best Day to Sell Weekly Options

Option traders, this may sound quite familiar to you; it may actually be you! Here is the short answer: weekend Theta is essentially decayed out of a position by Friday afternoon at 4:00 pm. Let me explain: most retail traders assume that Theta decays rather linearly. Basically, as time passes, your Theta decays at the rate that the trader’s trade software says it does.

See related: Understanding Theta and Time Decay

For instance, if certain trade software said a position had a positive decay of 10, most retail traders would assume they would have an extra $10 by the following trading morning.

Here is the problem, though: what about the weekend?

Market makers are not stupid (well, some are); they don’t like giving away free money. If the weekend didn’t decay out before Friday’s close, other traders would come in, sell a large amount of premium at the end of the day on Friday, and then buy it back first thing on Monday morning.

The traders who sold the premium would be very happy: they would have gotten the entire weekend’s decay—two-and-a-half days (Friday at 4 pm to Monday at 9:30 am)—for the price of one wakeup (Sunday at 4:00 pm until Monday morning).

So what do market makers do? It’s pretty simple. We begin to decay the entire weekend as early as we possibly can. Although every market maker manages this weekend decay differently, I can give an example of what I might have done when I was on the floor.

See also: An Option Signal Market Makers Count on

On Thursday at about mid-day, I would turn off all of my quotes. I would then go into my options quoting software and begin moving my software’s theoretical day forward to Friday (this is actually very similar to using the date function in TOS, OV, or Tradestation).

In this case, I would move my theoretical date from Thursday to Friday. Why? I would notice around then that other traders would begin trying to sell me premium. I obviously do not want to be buying a bunch of premium that will decay for two days on which the market is closed.

So I had two choices: I could lower my theoretical volatility. This would lower my options prices based on all of the premium sellers I was seeing, or I could move my theoretical date forward. If I move my theoretical date forward, I can lessen the theoretical value of the options using theoretical days to expiration instead of lowering the implied volatility. (This is the one time where the days-to-expiration portion of the five functions of a pricing model can matter as much as volatility.)

On Friday morning, I would already have my theoretical date to set to Saturday’s date. This was to stay ahead of the game. By mid-day, I might notice that I was seeing some premium sellers (by mid-day, I mean about 11 am ET).

Once I saw these sellers, I would move my theoretical date forward to Sunday’s date. At the close of the day on Friday, I would basically have my system set to 4 pm ET on Sunday.

Essentially, my system would have one wakeup (Sunday 4 pm to Monday 9:30 am) of theoretical decay left priced into the options I was trading. There was no “free” premium.

So how does this knowledge affect the retail options trader? Traders should note that the current software out there does not take this weekend decay function into account.

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But, the savvy option trader can! If I am in an option trade that is on the cusp of exit on a Friday afternoon, I am out of the position. There is not two-and-a-half day’s worth of premium to be made over the weekend, as I have already made a chunk of that Theta.

I would also like to note that a few people may read this article and think that they can make money buying premium. This is also not the case because the trader will still have to pay the wakeup decay (Sunday at 4pm until Monday at 9:30 am). Essentially, traders, there is no “weekend edge.” There is only the savvy option trader’s ability to be better than other traders!

The basis of this article is that, by Friday, there is almost no point in selling option premium, because the entire weekend is priced out of options ahead of the weekend. That has generally been the case over the last two decades of trading. However, there are periods of time where weekend decay does not come out of options completely.

During these time periods, typically, there is some sort of huge, risky event that is coming up over the weekend. Things like Greek deals and war declarations. One can typically see these weekend events coming because there is a clear evidence of something major about to happen: things like votes, announcements, and scheduled conferences.  

On these days, the VIX almost acts like stocks do ahead of earnings. Typically, the implied volatility (IV) increases because the options do not decay. Traders are trading a straddle price.

Then we have something like what happened the last three or four weekends:

Click to Enlarge

Ever since the Iranians began rattling their Kitara’s, we have seen two sides battling in SPX volatility. On one side are the level-headed traders who see the market doing nothing and having options premiums that are way too high. These traders are following the normal path an option will take over the week (lower into the weekend and higher on Monday’s).  

However, on Fridays, something interesting has happened around mid day: there are hedgers coming in looking to protect themselves from sort of even risk going on over the weekend. We don’t have anything specific, but just some unseen threat that is out there.

It is not completely evident in the chart above, but mid-week VIX action illustrates the action pretty well.

Click to Enlarge

Notice the volatility surge around 2 pm EST. It is like traders are putting weekend decay back into the SPX. If we consider that the weekend accounts for about .75% of any up move on a Monday, the movement up of over .5 points shows that they have a nice chunk of Saturday and Sunday in options.

The Trade: If one believes that the weekend is going to be a dud, VXX or VIX plays make a lot of sense. I have been doing this, and it will work until it doesn’t, or until it becomes clear something is about to happen.

By Mark Sebastian of

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