If you like to follow Adam Warner's tweets (something every real option trader should do) you know that every Monday he likes to remind all option traders that just because the VIX is up, does not mean that volatility is up. There is a weekend effect (you can read about it here) that causes the VIX to fall on a Friday and rally on a Monday. However, I have a hypothesis that some of the behavior is changing because of weekly options.
As many of you know the weekly options list on Thursday mornings, what many of you may not know is that a large chunk of the premium selling has migrated to those options over the traditional monthly options, especially at the retail level. Moreover, a huge portion of the premium sold in the weekly options is sold in the first day the options are listed. Another huge portion is sold the day before the options expire. This causes the weekly options to decay out a very large portion of their relative value in a short period of time on two instances over its life.
Wait, one might say, if the weekly options have a week to expire, they aren't in the calculation. Actually, on the first day they list, they really have 8 days to expire, and while they still are not included in the VIX directly, the affect of relentless selling in a contract month MUST have a spill over. Remember, all options in a given product are related, and while there can be variances in the term structure, the structure cannot get too crazy as the market arbitrages those opportunities away.
My thought process is that aggressive selling in the weekly options in SPX could be dragging down the months that are included in the VIX. Thus, selling in the options with one day and eight days to expire is dragging down regular June and regular July. Could this be the reason for the pattern we have seen over the last few weeks?
As many of you know the VIX has been getting smoked on Thursdays and rallying on Fridays over the last 6 weeks. While, I certainly think Geo-Political considerations are a part of the equation, I also think selling in weekly options is dragging the regular contract months on thursday, causing them to become over sold. Then, with the weekend possibly over decayed on Friday, and the fear of Geo-Political activities occuring over the weekend bringing a fear to the market, traders swoop in to buy somewhat cheap options on a Friday.
Obviously, this is just a hypothesis, but I think it could have some legs. Do any of you readers have any research that might back this up? It’s something I am going to be looking in to.
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Graph from: LiveVolPro
