Tips for Managing Expiring Options Positions
| Even the best traders can be maddened by expiration Friday. Expiration trading can seem so tempting. After all, look at the decay curve — options have so much value to lose the final day of trading. But expiration trading is difficult, and if you want to play with fire, you had better be able to take the heat.For a trader who can pick the right direction of a stock move, there is a plethora of opportune trades. However, these trades are hard to find and difficult to manage. But traders that do it right have a shot at being successful.
So, as we near another options expiration day, here are a few tips for managing a position into expiration. |
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#1 Don’t Think Expiration Week is Like Every Other Week
| Don’t be fooled. While there are varying degrees of increased volatility reported, virtually every study states that this week tends to be more volatile relative to standard trading weeks. Traders must be prepared to manage that extra volatility. | Double Your Money on Every Trade You Make |
#2 Do Not Underestimate the Power of Gamma
| There is a lot of premium to collect in the final few hours and days before expiration. But this premium is extremely difficult to collect when short options are trading around a strike. As the week passes, the gamma of a position will get bigger and bigger. Add this to the slightly elevated volatility, and that premium may not be worth the trouble. It only takes one big move to wipe out several days or even a month’s worth of decay. | Double Your Money on Every Trade You Make |
#3 Be Aware of Delta Drift
| As expiration week moves along, positions finishing in and out of the money will become more certain. This change in certainty causes options that are in the money to have deltas that approach the absolute value of 100, and options that are out of the money to have deltas approach zero.For instance, if Wal-Mart Stores, Inc. (NYSE: ) is trading at $51, the 50 calls will have to get near 100 delta at some point, and much of this transition happens during expiration week. Traders must understand a position’s true correlation to its underlying if they are going to profit.
Learn more about how delta affects options positions. |
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#4 Take Care of Cheap Open Shorts
| There is nothing worse than to have a short position that is worth a nickel or less come back and bite you in the hindquarters. It’s a story that has been told over and over again. A trader does not close an option that is worth 5 cents, and then on Thursday of expiration week, the underlying has a 3-4 standard deviation day that blows through the worthless short. Traders that want to trade expiration should try to keep the risk to one strike.
Learn more about why you should close out short option positions before expiration week. |
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#5 Try to Avoid Holding a Position Through Friday’s Close
| I’m not sure if I’ve heard more expiration week horror stories about blown-up worthless shorts or bad prints. We never know exactly where a stock is going to close. It only takes one large market on close buy order to make a short call go from a nice winner to a huge loser. Thus, even if a trader has to give up 10 or 20 cents of premium, it is probably worth the buy in. | Double Your Money on Every Trade You Make |
#6 Understand That Regular Expiration in Nothing Like the Weeklys
| There has been some tendency for stocks to pin strikes during weekly expirations. There are many theories as to why this happens; my thoughts are that it has a lot to do with the limited number of strikes that actually have large open interest. This is different from the regular monthly options, which can have massive open interest across several strikes. If a big player decides to close a trade that involved the options AND the stock, the unwinding of that trade’s stock position could have a profound effect on the direction the stock heads.
Learn more about weekly options. |
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#7 Pay Attention to the Size of Open Interest on the Strikes
| If an underlying is trading near a strike that has large open interest, that stock may pin there. This is caused by the owners of those options attempting to “scalp the gamma” of this option. If there are very large stock orders to buy and sell at or near the same prices, that underlying is going to have a hard time getting away from the strike price of that line with the large open interest. These strikes can be good to sell expiration straddles and butterflies on.
If a stock is hanging around a strike that has very little open interest, it probably does not have a large amount of resistance keeping the stock around that strike. These options may be decent ones to own … or not. If there is little open interest at any strike, it could simply be a stock that no one cares about. In that case, I would simply stay away. Learn more about choosing expiration day trades. |
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#8 Follow the Paper
| If the big money boys are buying straddles to open, it’s probably not a bad idea. If the big houses are selling to open, that is probably not a bad idea. If the big houses don’t care, the retail trader should consider taking a pass as well. | |
