Sheridan Options Mentoring Blog

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The Lure of Weeklies: One 1 Strategy and Four Tips Posted: 09 Jul 2011 01:23 PM PDT What's the fascination of Weeklies? Why is this the hottest thing in the options market? Buyers of weeklies use it as a hedge against their portfolios or individual strategies. They also like the fact that they can hit a home run if the price moves quickly in their favor.Sellers of options like the fast time decay and great yields you can get in 2-5 days. Let's face the facts: Trading weeklies is an adrenaline rush If you trade 30-day trades and now you can get potentially similar yields in 3-4 days, that's a huge temptation. The reality is that weeklies have existed for almost 30 years. The name was expiration week! Sure, expiration week only came once a month, but it was there for the taking. Bottom line:  life as well as options comes with pluses and minuses that accompany every decision we make. In weeklies, you have pluses of quick potential yields, fast time decay for sellers, quick potential home runs for option buyers. Minuses are price moves can smoke premium sellers ( strategies with positive time decay), and non-moving vehicles could wreak havoc on buyers. The risks and rewards are high! Strategy #1 Iron Butterfly (( For Premium Sellers, strategies with positive time decay) This involves selling a straddle at-the money and buying the strangle ( wings) for protection. An example in a $50 stock would be to sell 1 Aug 50 call and 1 Aug 50 put and buy 1 Aug 55 call and 1 Aug 45 put . This strategy will usually give you a great risk reward in that you will bring in a credit greater than your risk. A good risk/ reward is essential with weeklies. Many times you can make good profit in 2-3 days and get out because time decay is so great. If the market or your stock is more volatile, you can buy an extra call or put for insurance at the beginning of the trade , or as an adjustment. Four Tips 1. Use a small percentage of your capital for weeklies. If I'm doing $10,000 in Calendars, I may trade 10% ( $1,000) of the calendars using weeklies. It adds a little Louisiana hot sauce, but not too much! 2. When doing credit spreads, stay away from adjustments and just get out! Unless your're pretty experienced and nimble, adjustments can turn into a nightmare. When price movement goes against you with weeklies, it's like a locomotive coming straight on. 3. Also with credit spreads, keep your maximum loss on your trades at or under your normal winning months and you might actually have a credit spread business one day! 4. Stick with similar vehicles each month for familiarity Have a great summer and keep working on the craft! Dan Sheridan dan@sheridanmentoring.com

Lessons in Greek: Theta Posted: 09 Jul 2011 11:42 AM PDT My previous article introduced the concept of "the Greeks" and their applicability to characterizing the response of an option position to changes in both price of the underlying and implied volatility- delta and vega.  There remains one additional major Greek used to help understand the impact of the passage of time on an option position; this Greek is theta. I need to remind readers of the structure of an option price.  We discussed this anatomy in detail in last week's posting in the discussion of vega.  Similar to vega, theta is a factor which only impacts the extrinsic (time) portion of option premium. Theta is reflective of a unique characteristic of options.  Time, at least in our present universe, only moves in one direction.  Tomorrow there will exist one less day until expiration as compared to today.  Since the time to expiration represents one of the major inputs to the option pricing model, each day less that exists in an option contract is reflected in a lower time premium.  Harnessing the power of this "theta decay" of option prices represents a major point of advantage for option traders. Theta measures the reaction of an individual option or multi-legged option position to the passage of time. The concept of theta is particularly helpful in more complex option positions consisting of combinations of several individual positions.  In such positions, the response to passage of time is often not intuitively obvious.  This "position theta" is calculated by simply adding the theta values of each individual option position. For a given long option position, theta is always a negative number regardless of whether the option is a put or call.  The trader who wants to construct positive theta positions, structures that benefit from the passage of time, must include short options for at least a portion of his total position. In order to help understand the impact of theta on a position, let us consider the AMZN July 200 call.  AMZN is currently trading around $200; the 200 strike would be the current at-the-money series.  This option is currently priced at $5.30 and has a theta of -14.2. If price and implied volatility both remained constant until tomorrow, this option would decrease in value 14.2¢ as simply the result of passage of time.  As you begin to become familiar with these concepts, I find it easy to think in terms of options being an insurance contract.  In the case of owning a call, you have bought insurance to protect you against the risk of AMZN stock moving upwards beyond $200.  The daily premium cost for this insurance policy is the 14.2¢ that the value of the call erodes if all other factors remain static. The sensitivity of an option's price to theta is greatest in the at-the-money strike within an individual expiration cycle because this strike always contains the maximum dollar amount of time premium.  In addition, shorter dated options have greater rates of theta decay than shorter dated options. Theta decay is not linear, especially when considered in the framework of at-the-money options.  The classic pattern is to see relentlessly accelerating theta decay as options expiration is approached.  During the last month of an at-the-money option, time decay goes from a gentle green ski slope to a double black diamond slope in the last week of the option's life. The relentless and inescapable impact of "theta decay" of option positions represents a major "tailwind" for a variety of options positions and a secret advantage for the educated trader. Learning to capitalize on the relentless decay of option premium gives the knowledgeable trader a huge competitive advantage.

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