Weeky Options

The prospect of weekly options is an exciting one, offering many traders the opportunity to hedge with even more precision. It offers what is typically no more than that of an option with one week to expiry, but if strike prices are thoughtfully available, the concept of weekly options may serve to be more than a mere I week option; it could attract considerable volume from other option markets and even expand net open interest.

Having said this, weekly options by virtue of their brevity, are likely to be the riskiest options available. While premiums are often what newcomers to the option markets find alluring, the slight premium of a weekly option can be elusive.

Again, a weekly option is no different from a 3 month option, a 6 month option, or any other option of longer maturity. Its mechanics are the same, and indistinguishable when entering the last week to expiry. Given this mathematical relationship, arbitrage opportunities may arise if administrative costs will allow.

For the buyer of options, the last week to expiry has traditionally been the best value. Premiums are shamefully cheap, and often the underlying market will move sufficiently to hedge with gusto. Here, the mathematical model indicates considerable vulnerability, for an annualized volatility is the farthest aspect of reality when an option has one week to expire.

With such a short life span, the gamma of an option will experience profound change on many occasions within one trading day.  This of itself will reveal that volatility is invariably found to be too low when an option has one week to expire.

When volatility is increased within the model, the Vega (the premium change for a 1% increase in volatility) will be modest. Volatility will need to be increased dramatically to affect a change of any real magnitude. Of course the delta output from the pricing model will also be altered but similarly, will fail to reflect the precision required for hedging numerous times during one trading day.

For these reasons, many traditional grantors of options will seek to be reverse positions to a relatively flat position in the spot contract about to expire, directing their attention to the following delivery period. Buyers may well experience windfalls due to the dual advantage of short expiry and a vulnerability in the pricing mechanism, but sellers are in direct line for disaster unless sufficient premium is received; but for an option precisely at-the-money, this is rarely the case.

Of course the reason for market volatility in the last week of a contracts life is a moot point. Each moment in the market has reason of its own, but occasionally certain events can trigger an unusual abandonment of one contract in the lead up to expiry, with the entire market focusing its attention elsewhere.

When the tick value of a contract is experiencing transition for example, or if margin requirements have escalated overnight, traders will seek to close out positions and trade an alternative contract. With one week to expiry, the spot option is now a veritable ghost town which may provide some trading opportunities as spreads can widen, and premium can increase sufficiently to satisfy a seller’s criteria.

 

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Comments

  • 11/5/2010 11:06 AM Stoya Geren wrote:
    Weekly options are great for us to laveraging our money. The mechanicks are the same and given the mathematical relatianship we can use to make money
    Stoya
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