The CME Group has spent the last few years adding weekly options to their product arsenal. Their goal has been to provide speculators with more “options”, but they’ve also succeeded in finding a way to increase trading volume and, thus, their bottom line. In other words, weekly options have been a success on all fronts.
According to the U.S. futures exchange giant, weekly options provide users with increased flexibility in managing existing option positions, and new opportunities to trade high impact economic events. In my opinion, this is an accurate description for those that understand their advantages of weekly options, but are also aware of the limitations. The purpose of this article is to discuss both sides of the coin for various type of traders.
What Are Weekly Options?
Weekly options are simply options that expire at the end of each week, rather than once a month, or less, as traditional options typically do. The CME Group has listed weekly options on their most popular complexes such as Treasuries, Grains, and stock indices. In each of these products, the weekly options expire on the Friday of each trading week that is not already an expiration day of the standard (monthly) version of the option.
For example, the June monthly options in the Treasury bonds and notes expire on May 22nd. Thus, the May weekly options will expire on each of the Fridays in May that are not May 22nd (ie. May 1st, May 8th, May 15th, and May 29th).
Advantage Of Weekly Options
Price
Weekly options tend to be cheaper than options that expire monthly because under most circumstances the expiration date tied to the weekly options is sooner than that of the corresponding monthly options. Accordingly, they are often trading at lower premiums to enable traders to establish cheaper, and, therefore, lower risk, speculations. With that in mind, we’ll later point out that lower risk isn’t always the same as less risk.
Flexibility
Due to frequent expirations, and relatively lower premiums, weekly options offer substantial flexibility to traders. This is primarily true because of the ability to hone in on a certain economic event or release. Thus, option speculations can be targeted to certain time frames. Prior to weekly options, the luxury of efficiently speculating on short-term events was only available to futures traders. In many ways, weekly options are superior to trading volatile events with futures. Unlike futures traders who must choose between suffering large and uncertain losses, or they risk getting a stop order elected at an inopportune time (moments before the market goes in the desired direction), weekly option traders can limit their risk to a known amount. Additionally, they will never be forced out of a trade on a knee-jerk reaction because even an option that is losing money has the ability to come back to life and perform for the trader at any time before expiration. Simply put, it provides short term traders with lasting power despite volatility.
Cheap Insurance
Because weekly options can be purchased at low prices, they also provide an attractive method of insuring against losses on high risk speculations. For instance, a trader that wants to go long an e-mini S&P ahead of a non-farm payroll report, or a corn bull looking to purchase a futures contract before a USDA announcement, might find it worthwhile to purchase a weekly expiring put option against their long futures contract to provide insurance against being catastrophically wrong. Of course, traders can employ the same strategy using the monthly options, but monthly options typically require a larger cash outlay to purchase insurance.
Option sellers can also provide a hedge against disaster surrounding big announcements via the purchase of weekly options. For instance, a trader that is bullish the stock market might sell a monthly expiring ES (e-mini S&P put) and then purchase a weekly ES put for less premium to reduces the risk of the trade. The result is a lower risk and lower margin premium collection strategy.
Disadvantages Of Weekly Options
Quick Time Value Erosion
Although short expiration dates are the primary benefit of weekly options, they are also their biggest downfall. Because there is often little time to expiration, the value of weekly options can erode quickly in quiet markets; or even quicker if the market is moving away from your position. For instance, a trader purchasing a weekly corn-call option expiring on Friday, in hopes of catching a USDA report induced rally on the Tuesday before, could see the value of his option implode following the USDA report if it doesn’t trigger the desired reaction (rally). In fact, even if corn does rally on the USDA news it often doesn’t move far, or fast, enough for call options to benefit. This is true of any type of option, but the obstacle is magnified for weekly option traders. Thus, option buyers must be at peace with the feast or famine nature of speculating on weekly options. Only the massive market moves will provide positive returns to a weekly option buyer – simply being right about market direction isn’t enough.
On the other hand, option sellers often look to weekly options because the time value erosion can be accelerated. Nevertheless, selling weekly options is far from easy money. Although premiums are cable of quick erosion with the passage of time, due to the short-dated nature of the contracts, traders typically must sell options with strike prices that are relatively closer to the fire (the current market price) to make it worth their while. Should price volatility explode, being a short-option seller in the weekly options could feel like picking up pennies in front of a steam roller.
Liquidity
The liquidity of weekly options has picked up nicely in a relatively short amount of time, but they aren’t nearly as liquid as their monthly counterparts. Nevertheless, for the most part, there are capable market makers, and relatively fair pricing to create an attractive arena for speculation.
Not all U.S. exchange product offerings have been able to achieve instant liquidity; those of us that have been around for some time remember real estate futures and single stock futures. Listing these products on exchanges for speculators seemed like a better idea than it was in reality.
It can be difficult to build market liquidity in new markets because nobody wants to be the first person to the party. After all, the perils of trading illiquid market include increased transaction costs due to higher bid/ask spreads, and the potential of inexplicable and dramatic price moves on the heels of a single trader’s order. In extreme cases, it might even involve being trapped in a contract because there isn’t a trader willing to take the other side of your exit order.
Thankfully, the weekly options never experienced that sort of extreme dry market. Instead, they’ve attracted speculators of all types, sizes, and experience levels. More importantly, there are market-makers quoting bids and asks in weekly options to give speculators an attractive venue to trade.
Generally speaking, the weekly options are liquid enough to be considered, but probably shouldn’t be traded in overly large quantities until things pick up a little more. Before entering a trade, you should be aware of the activity in the particular contract, expiration week, and strike price of the option you would like to trade. Volume can be dramatically different from one week to the other, and even from strike price to strike price within the same week.
Conclusion
Weekly options can be a great tool for speculators, but, in my opinion, they are best used by those wishing to hedge speculative positions made elsewhere. Further, long-option traders should avoid being lured by the fact that weekly options seem cheap because their proximal expiration dates often don’t give the market enough time to make the desired move. Thus, a weekly-options buyer might be forced into purchasing multiple consecutive weekly options before the anticipated market direction actually develops. In such a circumstance, it might be difficult to recoup losses sacrificed to rapid time decay. Simply put, there is a time and place for weekly options but employing a short-dated long option strategy in this complex could be an expensive venture in quiet, to normal, market conditions.
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*** There is substantial risk in trading options and futures. It is not suitable for everyone.
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