Adam Warner

What's in Store for Options Traders?

by Adam Warner    11/16/09

Free Trading Guides

 

Options traders are currently facing an impressive headwind of seasonality, and there are three things that will affect their trades from here through the end of 2009.

The first is expiration week. Options expire on the third Friday of every month, and November options are set to come off the board at the end of this week.

 There are a number of myths associated with expiration week, the biggest one being that it is a time of random and excessive volatility, and all but the bravest souls should just pack their bags and return the following week when things have calmed down.

While volatility surrounding expiration is something you need to be aware of and take into account when making trades, by and large, expiration week is not so different from a typical week that you should just sit on the sidelines.

It's true that expiration week is modestly more volatile than a typical week, and it does feel like you see more trend days than normal. But it is highly probable that option volatility will be lower across the board this time next week.

Why is this?

Well, the most common options strategy was, is, and probably always will be the buy-write -- a covered call strategy where you simultaneously purchase the stock and write a number of calls representing the same amount of shares as the long stock position. When the "write" part of this strategy expires, traders generally roll it in some fashion into another options cycle. This causes natural selling pressure in options and lower volatility on the margins right around expiration day.

The next thing traders should be mindful of is the shortened holiday week on tap. The market will be closed Nov. 26 for Thanksgiving, and will close early on Nov. 27.

Options traders tend to assume that there is less "time" in an option then the calendar actually says there is, and will adjust their models accordingly. Even though their reasoning has more to do with time than lower volatility expectations, the net effect is it lowers the actual implied volatility on the board.

Finally, in general, December is just a bad month to own options.

I ran some numbers for my recently released book, Options Volatility Trading: Strategies for Profiting From Market Swings, comparing implied volatility to realized volatility in each expiration cycle, and found December to provide the worst value for options owners.

This is the case for a couple reasons. It's partially due to holiday hangovers and the news vacuum that tends to occur. Plus, it's the time of year when fund manager types like to run out the clock.  

How to Trade December Options

So what does this all mean for the options trader?

Generally speaking, you should time your options transactions accordingly if they involve going long or short gamma. Gamma is the rate of change in delta as the underlying moves. (Learn more about the option Greeks.)

If you plan to net sell December options, you should start now. Even if we see some swings this week, it's unlikely December options will get a big lift.

If you plan to net buy December options, don't rush, or buy January contracts instead. We obviously have more holiday lulls ahead to deal with, but with January options you'll have earnings season and the natural reshuffling at the beginning of a calendar year to help move your positions.  

---

How to Profit From Market Manipulation
The market is rigged! Learn the single best way to make huge profits from everyday market manipulation. Get your free copy of "How to Find the Money-Doublers in Today's Market" here.