Option traders, over on Option 911, Mark Sebastian wrote a piece called "How Time Premium Decay's Over the Weekend." Thankfully it caught the attention of a few bigger bloggers and here we are, the best option mentoring firm on out there, articles that are published nationally, a great magazine, and a great blog. In that time, the market has taken some crazy terms. IV has been smoked, bid up and smoked again, we have had a flash crash, and we have had weekly options begin trading. We believe there is some serious opportunity in the weekly options if traded properly. Never, have we received more vitriolic emails than after our article on the weekly condor. We stand by our belief that the risk reward is not there. This does not mean there isn't opportunity in weekly's, as we stated, we believe just the opposite.
This leads us full circle to the original article that discussed how option time premium decays. The concepts in that article are even more important in the weekly's than in the standard monthly options. Here is why:
Review:
If you do not feel like reading the whole piece here is quick synopsis (although it is a good read):
-Option Time Premium must account for the decay that takes place over the weekend.
-Since there is not trading on the weekends, this decay must come out during the week otherwise there would be a 'free lunch' to the sale of the option.
-Market makers take out much of the weekend time decay by end of day Thursday, and certainly by Friday afternoon
-It does not make sense to sell options on Friday afternoon's in most circumstances.
How does this apply to the weekly's?
We took a look at all of the AAPL weekly straddles that have traded since their July earnings. In every case, save one example (which we will discuss tomorrow), there was actually MORE decay between 9:30 EDT on Thursday and 4:00 on Thursday than there was during that same period on Friday. Moreover, by the end of the day on Friday, the AAPL straddle had lost around 25% of its value by the end of the day on Friday. This is much larger than the Greek would predict on Thursday mornings. Take Aug 19th for example:
With AAPL trading 252.50 the AUG Weekly straddle was priced at 8.55, with a decay of .52 cents a day and a delta of 30 and gamma of 8.30. At the end of the day the straddle was priced at 7.30. If we take out the time decay, for the WHOLE day and the change in price caused by delta the straddle should be priced at about 7.70. What happened?
If one considers that 22% of the weekly option's life is the weekend then one might grasp the gravity of understanding weekend time decay when trading these products. The market maker's have to do something about his decay that takes place over the weekend. The answer, the market makers began decaying a big part of Friday on Thursday. This comes out primarily in the morning. By end of day Friday, the market makers have decayed the weekly straddle down to where it should be on Sunday night. This can be seen visually by the reduction in implied volatility of the ATM straddle. Yet again, our old time decay chart doesn't quite work right.
Conclusion:
In most cases, it actually makes sense to sell the fly/straddle on Thursday's in the morning, maybe in the first half hour, instead of waiting. There is some risk of price movement in the first few minutes, but it may be worth it. There is an exception, we believe, to this rule that I will discuss tomorrow.
If you have questions about this please email us, info@optionpit.com, call us (888) Trade-01, or check out our AM Pit Report.
