Options trading becomes more and more popular every year. The options become more liquid and more traders use them for hedging, speculation, income etc. Weekly options (weeklys), introduced by CBOE in October 2005, are one-week options as opposed to traditional options that have a lifespan of months or years before expiration.
There are hundreds of options trading “gurus” promising you all kinds of ridiculous returns like “5% per week” or “10% per month”. What most traders don't realize are the risks that come with those returns.
What are Weekly Options?
As a reminder, options expire on the third Friday of every month. Weekly options, first introduced by CBOE in October 2005, are one-week options as opposed to traditional options that have a life of months or years before expiration. New series for Weekly options are listed each Thursday and expire the following Friday. In fact, many stocks now have weekly options going as far as 5 weeks.
Not every stock or index has weekly options. For those that do, it means that every Friday is an expiration Friday. That opens tremendous new opportunities but also introduces new risks which can be much higher than “traditional” monthly options.
Make 10% Per Week with Weeklys?
Question from a reader: What about selling the weeklies? The timeframe is very short and if you are more conservative, you can skip the weekends and start the trade on Monday and bet on about 4 days. You can still get about 10% return per week with very little risk.
To earn 10%, you must allow the options to expire worthless. That involves much more risk because each day comes with the tiny possibility of market-moving news.
If you can earn 10% per week and compound those earnings, after one year, $1,000 would become $142,000. I’m sure you cannot expect to win every week, but I hope that you recognize that it is impossible to earn such reruns with low risk.
I believe that your plan is fine for the experienced, disciplined trader who is skilled at managing risk. However, it is far too dangerous for the novice trader.
Be Aware of the Negative Gamma
Many options “gurus” ride the wave of the weekly options and describe selling of weekly options as a cash machine. They say that “It brings money into my clients account weekly. Every Sunday my clients access their accounts and see + + +.” They advise selling weekly credit spreads and present it as a “a safe option strategy because we’re combining an option purchase with an option sale resulting with a credit into your account”. What is the biggest issue with selling weekly options? The answer is the negative gamma.
The gamma is a measure of the rate of change of the delta. The gamma of an option is expressed as a percentage and reflects the change in the delta in response to a one point movement of the underlying stock price. For options buyers, the gamma is your friend. For options sellers, the gamma is your enemy.
Selling weekly options will give you larger theta per day. But there is a catch. Less time to expiration equals larger negative gamma. That means that a sharp move of the underlying will cause much larger loss. So if the underlying doesn't move, then theta will kick off and you will just earn money with every passing day. But if it does move, the loss will become very large very quickly. Another disadvantage of close expiration is that in order to get decent credit, you will have to choose strikes much closer to the underlying.
Here are some mistakes that novice traders do when trading Iron Condors and/or credit spreads:
• Opening the trades too close to expiration. There is nothing wrong with trading weekly Iron Condors – as long as you understand the risks and handle those trades as speculative trades with very small allocation.
• Holding the trades till expiration. The gamma risk is just too high.
• Allocating too much capital to weekly options.
• Trying to leg in to the trade and time the market. It might work for some time, but if the market goes against you, the loss can be significant and there is no another side of the condor to offset the loss.
Does it mean you should not trade weekly options? Not at all. They can still bring nice gains and diversification to your options portfolio. But you should treat them as speculative trades, and allocate the funds accordingly. Many options “gurus” describe those weekly trades as “conservative” strategy. Nothing can be further from the truth.