How to Trade Options Expiration

06/13/2011 4:00 pm EST

Focus: OPTIONS

Joe Kinahan

Chief Market Strategist, TD Ameritrade

Trader and derivatives expert Joe Kinahan discusses some of the important adaptations traders must make as options near expiration in order to manage risk and avoid common pitfalls.

If you trade options, expiration week can be a little tricky. There’s some things you need to know, and some pitfalls to be aware of.

Our guest today is Joe Kinahan. So, Joe, expiration week; does it change how you trade options?

Well, yes, it does. The funny thing is now is you can have expiration every single week if you want with the introduction of weekly options almost, I guess, close to a year ago now.

But expiration week certainly does change how you’re going to trade because those who are familiar with options par lines—you know, Deltas, Gamma, Theta—those numbers really get pronounced significantly during expiration week.

So one of the things you’re going to have to do if you’re an options trader and you have different positions in different months is kind of take that part of your position out and consider it a little bit separate from the rest of your position, because on Friday, those all go away, so you have to really be looking forward to “Where am I going to be that next Monday?”

You know, the great thing about options trading is you’re always looking “Where am I going to be,” and one of the pitfalls I see is people are like, “Oh, I should have done this; I should have done that.” Well, you didn’t!

Let’s talk about what you’re going to do; that goes for all trading, but it’s particularly pronounced in options.

Now, options that are out of the money by quite a bit during that expiration week may seem cheap because it’s getting close to expiration—that time decay—yet I think traders might be enticed to go grab them because they are cheap and hope that the stock moves, but it’s going to have to move quite a bit in that underlying to actually make any money for you.

Yeah, and you know, you’ll always have to look…options are probabilities; and the probabilities that those are going to be in the money are very, very low.

In fact, I usually try and take the opposite view and say if I’m short those and they’re trading for a nickel or less, I’m going to buy those in, you know, get rid of the junk, get rid of where there’s a little risk that can all of a sudden blow up on me.

So to go out and speculate on those is probably not the best use of your capital.

You mentioned getting out of a trade and getting into something new. Is that something I should do before options week and roll them over into the next month?

Well, one of the things I usually like to look to do because I—you know, having traded in the pits for years, knowing professional traders—they’re usually doing it four to ten days before expiration. Why wouldn’t I, then, be doing it four to ten days before expiration? 

You don’t have to say, you know, if it was the February expiration, “This is February, I already traded February.” Then Friday comes, and the next Monday, “Now it is March, I trade March.”

It’s a constant rolling game. You should be looking ahead all the time, and, you know, people are always afraid of assignment and exercise risk. If you close those positions out four to ten days before, you’d take a significant portion of that risk out.

And overall, with options trading, if I’m just getting started, should I avoid options expiration week altogether?

I wouldn’t say that it’s the time you want to open positions. Options expiration week is the time for closing positions, and again, looking how professionals do it, they’re closing in that week. They’re not trying to open new stuff. They’re always taking risk off the table.

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