Trade Options Expiration Like the Pros

11/15/2011 8:30 am EST

Focus: OPTIONS

Joe Kinahan

Chief Market Strategist, TD Ameritrade

Joe Kinahan discusses "witching," or options expiration, reviews the common mistakes traders make during these times, and tells how the pros protect their profits and avoid excess risk.

If you are a trader, you have no doubt heard about Friday options-expiration days, called “witching,” “triple witching,” or “quadruple witching.” Our guest is here to talk about that today, Joe Kinahan. So Joe, first of all, what is “witching?”

Witching is when many things expire at the same time; it happens four times a year. It happens on the third Friday of March, June, September, and December; so the normal quarters that people are used to.

Four products expire at the same time: You have futures expiring, futures options, equity options, and weekly options all expiring on that day.

So how does that affect my decisions as a trader as we get closer to that?

Well, there is going to be a lot more volume, first of all; you know that. Many will say there will be more volatility, but I think the mistake that many retail traders make going into this is they wait until the Thursday or Friday of expiration week to unwind everything. 

If you will notice, the week before that; the Wednesday, Thursday, and Friday the week before expiration, you will start to see volume increase as the professionals are already unwinding their positions. 

The Tuesday and Wednesday of expiration week, we really tend to see more volatility and volume, because by the time Thursday and Friday come, most of the professionals want to be out. They don’t want to have to take any more risk.

They have milked positions, they have done whatever they need to do. It is time to roll out or take off the positions.

See related: How to “Roll Up” Option Profits

You have to be very careful that you don’t get caught up in a game where you are trying to get every last penny. Not that there is necessarily anything wrong with that, but I think you have to start looking at your risk/reward.

Are you tying up a huge amount of margin to make two extra cents? Probably doesn’t make a whole lot of sense for you to do that.

So even if I am not in the options market, I need to be careful if I am just trading stocks. What do I need to watch over here? 

Again, there is going to be volume; there is going to be volatility. These big houses will have the major stocks, say General Electric (GE), IBM (IBM), against futures. So it is a basket of stocks versus futures. They may be long one, short the other, and they start unwinding the individual stock names versus the basket.

Really, as an individual investor, it is time not to panic, even if you are just a stock trader, just kind of sit still and realize that we are going to wobble up and down throughout those few days. Just go to normal trading right after that.

So if I am a newer trader, does this mean I should probably just sit out that day entirely, or are there maybe some lower-risk ways I can actually make money during this time?

There is always opportunity, and in any case, I would say the biggest thing you want to do is cut your size. There’s nothing wrong with trading, but you might want to trade a little bit smaller so you are more nimble. 

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