Understanding Weekly Options

08/21/2012 3:21 pm EST


Dan Passarelli

Founder, Market Taker Mentoring, LLC

Option trader Dan Passarelli discusses some of the pros and cons of trading weekly options and shares his insights on why options sometimes seem pegged to a round number strike price.

Weekly options have been around for a while now, and traders have built up good strategies for using them.  My guest today is Dan Passarelli to talk about how to use weekly options.  So Dan, weekly options are relatively new, but they've been around for a while.  People are comfortable with them now.  Give us some ideas of some good starter strategies for these.

Weekly options can be really great options to trade whether you're a buyer or a seller.  When a trader buys options—for example, just simply buying a call because the trader is bullish—whatever the trader invests in that option is his maximum loss. 

Weeklies, because there is so much less time to expiration than a monthly or a two or three-month option, consequently they're a lot cheaper.  So the trader risks significantly less.  So if the trader is looking to hold an option for a day or two or three—like either a day trade or a swing trade—buying weekly options can be fantastic.

How about the theta, the time decay on weekly options?  If I'm five days out from expiration, is it the same kind of theta that you've seen on a monthly option that's five days away from expiration?

Right, great question.  The theta is significantly higher with weeklies.  So that's why I say if you're thinking about holding the trade for a day or two or possibly three, it can make sense.  You're paying for that benefit of having that lower cost, lower risk option in terms of theta. 

That's why a lot of traders like to sell the weekly options, because you get that high rate of theta.  So when you put on say a credit spread, a butterfly, something in the condor family, or even a time spread using weekly options, that high rate of theta can be really advantageous to the trader.

I was just going to ask, do you find that those spread strategies work just as well, if not better, with those weeklies?

They can work a lot better.  Here's the thing with weeklies.  You get that advantage of the higher rate of time decay—huge advantage—but sometimes you can't find the trade.  Because the option premiums are so much less expensive—you know, nominally speaking just lower valued than a longer-term option—sometimes you can't sell these spreads for enough to make it worth it.  So what I tell my students is when you can find a good weekly trade, it's probably a great trade so jump on it.

What about this idea of pinning that the weekly strategy will come close to a round number in the stock as just kind of a general phenomenon. Is that happening?

Yes, that does statistically happen more often than what the numbers tell you it should happen, and that has a lot to do with kind of the mechanics of the liquidity providers—essentially the gamma scalp.  So when the stock rises above the strike price, they're forced to sell stock just to hedge themselves—not because they're bearish, but just to hedge their deltas. 

Then when the stock falls below the strike, they're forced to buy stock because they get short deltas, and they're forced to hedge and buy stock not because they're bullish, just to eliminate their directional risk.  So the selling above and buying below tends to push the stock towards a strike price.

Dan, thanks for being here.


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