Monday, October 11, 2010

Bigger Gains, Less Time. Tap Into the Potential of Weekly Options

From Price Headleyone of the most respected authorities on Options....

Traders spoke, and the exchanges listened. And, if the growing popularity of the new weekly-expiration options is any indication, these shorter term puts and calls will soon join their monthly-expiration counterparts as mainstream trading instruments.

Just as the name implies, the newest innovation in option trading are derivatives that are issued on Thursdays, and then expire the following Friday.... six trading days later.

But why bother with short duration instruments when the traditional monthly expiries have been working fine for all these years? There are actually quite a few advantages these instruments boast that simply can't be said for the alternatives. Consider this:
• Weekly options inherently offer a greater 'delta'. That just means each of them are more responsive to changes in the underlying security's price during their lifespan than monthly options are.
• Weekly options don't suffer from a high 'theta'. In other words, time decay isn't a major impediment for weekly options. Since they're so short in duration, there's no excess time value (or premium) baked into the price. As a result, weekly options tend to cost less.

While those two details are the favorable technicalities, the overarching attraction to these new short-term derivatives is not only 'bigger picture', but much more important than the high delta and low theta..... weekly options are amazingly flexible.

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One of the more challenging drawbacks of trading traditional options has been the misalignment of a trader's timeframe and the option's lifespan.

For example, a trade's "sweet spot" may end up spanning the last week of one month and the first week of the next month. However, since monthly options expire right before that sweet spot has occurred (and are issued several weeks before that period), a trader may be forced to choose an option, expiration, or strike price that doesn't fully maximize a trade's potential.

Said another way, a lack of choices of when an option's life begins and ends means the trade's theta and delta aren't ideal, leaving money on the table.

Weekly options, conversely, are new every week, so a trader can pick and choose to step into a trend that's moving at the time. Or, he or she can choose to pass on a trade that's stagnant at the time. And what happens when the underlying stock or index starts to move again? No problem - just step in again with the next weekly issue. There's no need to waste time and tie up capital by holding an option during the underlying security's dead periods.

And what sorts of securities or indices currently offer these weekly options. All the usual suspects in terms of indices are available.... major indices like the S&P 500, and weekly options for some of the major sector ETFs are on the table as well. A few of the most highly-traded stocks are in the fray too. Since these are issued on a revolving basis at the discretion of the exchanges though (largely depending on demand), you never know which stock you may be able to play this way in the future. [Indeed, many traders have used them as a way to leverage a position for purely a one time event, like an earnings announcement.]

While the advantages of trading weekly options are clear, a new set of trading mindsets and rules also apply:
• Get your short term charts and ebb/flow predictions ready. One of the primary reasons equity and index options exist in their traditional time frames, with a lifespan of months if not more than a year, is to offer an active investor a way to leverage his or her capital, while allowing that same trader to ride out rough patches on the way to the end goal. Weekly options, on the other hand, are a short-term chartist's dream. The key question is, where will this stock/index be in a week (or less)?

• Use the market tide to your advantage. In the same vein is 'think short-term', traders should tap the market's near term tidal forces.... since 3 out of 4 stocks tend to move in tandem with the market's strong moves. Yes, given enough time, the best individual stock trends can defy the market's ebb and low. The whole point here is speed though, which means calling the market right at any given time is half the battle (whether you're trading stock or index options).

• Keep the original intent in mind. It's contrary to most everything we've been taught as investors, but the whole point of weekly options is to reap the benefit from a short-term move; get in and out accordingly. Some traders are using them to profit from news announcements (like earnings). Others are just using them to hedge a position through a certain timeframe. Don't be afraid to cut loose once your reasonable objective has been met.

The proliferation of weekly option trading is sure to be a beneficial one for traders. Like any other trading arena though, it's the mastery of the nuances more than the mechanics that will be the key to your success.

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