As every options trader knows premium decay can surprise the holder of long puts and calls.
The process of time decay is even faster for weekly options. Weekly options, decay rapidly, but this does not need to be a detriment if the trader is aware of the process of time decay.
Time decay happens more rapidly as we near expiry, traders of monthly options generally see the premium decay kick in around the last two weeks before the option expires. If the price of the underlying stock does not change, the value of the option decreases rapidly. With weeklys this happens in a more predictable fashion.
IMPORTANT RULE
As a rule of thumb, time decay does not take place until Wednesday of the week of expiry. This is a powerful piece of information to traders.
STACK THE ODDS IN YOUR FAVOR
- There is no advantage to selling on the Friday prior to the week of expiration, the market makers know that traders want to take advantage of the two free days, so they hold premium constant over the weekend, you do not get two free days.
- You have Monday and Tuesday to get the entry you want, as premium will not change over those two days.
- Ability to sell overnight spreads, that take advantage of roughly 30% premium decay per day from Wednesday to Friday.
The long side of weekly options is where the premium erosion will hurt the trader. With weeklys the better way to trader to be the seller of premium. There are many ways to do this but a vertical spread is probably the easiest way since you are able to limit your risk
USE ANALYSIS SOFTWARE IN YOUR TRADING PLATFORM
If you want to get a better grasp on how premium decay will affect your trade take a look at the theta analysis for the trade you plan on setting up. Not all software has this function, but if it does it will indicate the dollar value of the option value that you are losing or gaining each day to premium decay. If the number is negative as in the case of a long option position, this indicates that it is costing you money to simply hold the option. In the case of a short options position, the value will be negative meaning that you are getting paid or collecting premium each day.
PREMIUM IS HARD TO GET BACK
Once premium has disappeared from an option, whether it is weekly or monthly it is very hard to get it back. I will give an example to help illustrate this point. Say IBM is trading for $200.00 on Monday and you buy a weekly call for $5.00, IBM has a sharp drop in price and the option is now trading at $3.00, for the option to ge t back to $5.00 IBM would actually have to rally to more than what the price was when you bought the call. A way to help alleviate this is to buy a deeper in the money put or call, as they will have less premium. But this is a balancing act as these deep in the money options will be more costly since they are deep in the money.
BOTTOM LINE
In conclusion if you are trading weeklys, watch how premium decays and stack the odds in your favor, sell premium, use spreads, and don’t get fooled in to thinking that the weekend will provide you with two free days of decay.
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