Option Traders, this time of year one of the most common questions I get from my option mentoring students is "Mark, What I can get you for Christmas." The next one I get is: "How much time premium will come out of options before the upcoming holidays?"
This question has a simple and yet not simple answer. Generally, I think about it time premium the same way I do a weekend (see here). That is a pretty simple calculation. However, how many days should the trader price out, what theta number should the trader use, and when will it happen are all much more difficult questions. Here is my approach:
1. The year we have the 24th, and the 31st off, and the holiday's over the weekends. We do not have any half days. There for I will generally price out 6 full days of decay. In years where the holidays are in the middle of the week, I will price out more than that because of half days, days when there is no 'real' trading etc.
2. I generally use the Theta and vega numbers from the 31st to calculate my total volatility and premium that will be priced out. This accounts for the slower trading during the time in between the days off.
3. Figuring out when it is priced out it a little more difficult. My general though process is that it will certainly come out by the Tuesday before Christmas if not sooner.
So how much decay will come out over that time period and what will the effect on volatility be?
In the SPX, the theta will be about .42 a day, the vega will be about 1.20. My best guess is they will take out about $2.50 of the ATM options before Christmas. A decrease in volatility of about 2%. Have they already started to take some of this out possibly? What are your guy’s thoughts?
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Data from CBOE.com
