Weekly options are increasing in popularity because they present the options investor with some unique opportunities to trade. Let’s take a look at weekly options in more detail to see how they can be incorporated in to your trading plan.
THE BASICS
Weeklies can be traded on stocks, futures and the cash settled stock indexes like the S&P 500 Index (SPX). Weeklies work just like a regular monthly options except that they have a much shorter life. Weekly’s have the potential to allow a trader to replicate their strategy a few times per month, increasing the revenue they can generate on a monthly basis.
KEY POINTS
The major hurdle that new options traders face is understanding how the price of an option will change while you are in the trade. The two most important factors are the price of the underlying, and time to expiry of the option. The fear most traders have is that since weekly options are around for just such a short amount of time there is very little chance that the trade will work out. Traders who buy out of the money weeklies know this all too well.
Traders know there are two sides to every trade, if you are long there is someone else taking the short side of the trade. This presents a unique situation for income generation with weeklies. If buying out of the money puts or calls and hoping for huge rewards leads to losses, 9 times out of 10, then why not look at the other side of the trade? Why not sell puts and calls, collecting the premium and taking advantage of the rapid time decay instead of having it working against you. You will not make 1,000% on your investment but this strategy can generate a weekly trading income. Selling naked options can be risky if the position goes against you since your losses can be unlimited in the case of selling a call.
LIMIT RISK
The key to weeklies is to limit risk. The first way to limit your exposure is to sell spreads. Spreads allow you to sell an option and at the same time allow you to know your maximum potential loss at the time that you place the trade. The second way to limit risk is to sell options with strikes that are statistically outside of the weekly expected move of the underlying stock.
YOUR EDGE
Combining these two strategies gives you the edge in the weekly options game. As a trader I believe that risk increases exponentially with the length of time you are in a trade. Who has not had a great stock trade turn in to a loss because of a surprise earnings announcement or downgrade? Most options traders believe that time is a benefit, but I argue that it can also increase your risk. I believe that most traders do not factor in this risk in their trading plans. Weeklies can reduce this risk in your trading as market conditions and surprises are less probable over a week, than a few weeks to a few months which is typical with traditional options investing.
BOTTOM LINE
The simple strategies outlined previously work well on stock options as well as options on futures and options on the cash settled stock index options like the SPX. There are many strategies that can be employed with weeklies that cannot be done with monthlies There are many ways to trade the weeklies which I will discuss in detail in future articles.
Until then look outside of the box when evaluating options trades, if you are rolling the dice on large risk small reward “gambles” for huge returns, think about the trader profiting on the other side of the trade making smaller but regular “income” from your losses, and allowing the rapid time decay to work to your advantage.
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