Lessons from the Pros

Back to the Weeklies

Having done three articles on the fundamentals of options, I feel that it is time to go back to our original discussion of the weekly options. Many times an option trader will notice that he or she has to go full circle, starting with the basics, and then moving on to more advanced options; afterwards, moving on even further to more exotic option strategies. After that entire journey, an option trader realizes that he or she must simply go back to square one. I have completed the full circle while learning options just as many of my friends, who are committed option traders, have done, too. Those readers who are about to embark on the "road less traveled" of option learning will, in due time, come to the same conclusion. Just as all the roads during the Roman Empire time led to Rome, all option learning will lead back to the basics and come down to two basic building blocks – calls and puts.

Where do the weeklies fit into the option trading? It all depends on a trader’s personal preference. Many of my close friends who are option traders have never traded them. In fact, they know very little about them because the trading media is not marketing them as much as it could. As I pointed out in my earlier article, Squeaky Quarterlies, the weekly options are hot in some European markets. The option traders in Amsterdam trade them quite frequently which created high option liquidity on the weeklies. Moreover, the increased liquidity leads to increased Open Interest on the individual option strike prices. In addition to it, the increased liquidity leads to a decrease in the spread between the Bid and Offer (Ask) of individual option premiums. Having these three components in place: (1) high liquidity, (2) large O.I. or open interest, and (3) small spreads, makes weekly option trading attractive.

After my initial article on the topic, Weak Weeklies, I have received several emails from Online Trading Academy students asking me to share with them one of my option trades on the weeklies. This is what I will do this week. For those who do need the refresher of what the weeklies are, I suggest rereading my articles mentioned above prior to continuing with this one.

As you might recall Monday, Feb 16th, 2009, the market was closed and we had a long three-day weekend – Saturday, Sunday, and Monday. This was a perfect trading condition for a net premium seller like myself. Hence on Friday’s close (02-13-2009), I decided to sell a Bear Call on the XEO (European option style of the Standard & Poors 100) after completing my usual routine of doing an in-depth technical analysis. I knew that the theta or time decay would be working in my favor. Hence, I sold the XEO options that had only seven days of life in them. Out of those seven days, the market was closed three days and my position could not possibly go against me during that time. Bingo – I love when the calendar days align like that and the stock market is closed for some type of holiday. It is then that the net premium seller’s dream becomes reality. Once again, I did not blindly place my trade. I planned it in advance and then I traded the plan. Just like we as instructors are teaching in all of our classes regardless of whether they are equities, Forex, commodities, futures, or options.

Figure 1

Figure 1 shows the date and time of my entry which was Friday 02-13-2009 at 15:45 EST just before the close. When the transaction of placing a Bear Call was performed, the XEO was trading at $391.34. The trade involved these two options: BTO + 1 XEO Feb 415c @ – 0.76 and
STO + 1 XEO Feb 410c @ + 1.31. Together they have produced the credit of (-0.76 + 1.31) fifty-five cents. While the spread between the strike prices (415c – 410c) was five points. The max risk was 5.00 (spread width) minus the max profit of 0.55 equaling 4.45. The rate of ROI (return on investment) was the max profit of 0.55 divided by the max risk of 4.45 = 12.3%.

Now let us turn our attention to the facts. I sold 410 call which means that I accepted an obligation. At the time of short-selling this call, the XEO was trading at 391.34 which was (410 – 391.34) more than 18 handles (points) away from the current price. All that the price had to do during the life of those options was to remain below 410. When I got into my position, the XEO was already trading 18 points lower. Had this gone up, it would have to go up the whole 18 points plus some change in order to challenge my sold position of 410 call. It never did, for it had only 4 trading sessions left.

Figure 2

Figure 2 shows another shot of my platform at the day of expiry – indicating that I have achieved my maximum ROI profit of 12.3% by selling a Bear Call spread. The XEO closed on Friday 02-20-2009 at 363.75 and my 410 call was at that point more than 36 handles away. On the Friday of expiry, I had no reason to pay any additional commission to my broker. Bingo again!

Figure 3

Figure 3 shows the Trade Station’s chart above. On the hourly chart, I have marked with the red line a clear downtrend that was confirmed on Friday 02-13-2009. I have indicated with a pink oval the time of my entry which was the very last hourly candle of that Friday. I also marked each trading session by naming the days, as well as where the expiry occurred.

In short, this article was aimed to present a type of spread trade that could be placed using the weekly options. At first the profit that I have received might not appear as much, yet a trader should be focused on the risk that has been taken rather than the dollars and cents of the reward. As a side note, this type of trade would not make any sense if the commission involved could eat up all the profit. In my case, the commissions were 1.50 per leg, and I paid only two commissions at the entry – period. So out of 0.55 cents of profit I could subtract those 3 cents, which would then slightly change my outcome in the terms of percentage. In that case, I must divide 0.52/4.48 which still gives the ROI of 11.6%. This is more than what I could get at banks with a C.D. (Certificates of Deposit). In terms of delta, I have sold a deep OTM (out of money) call which had the delta of less than 20 cents. As I mentioned in my earlier articles, the delta contains within itself the probability of expiring ITM (in the money). When I sold the 20 cents delta, the buyer of my call had only a 20 percent chance of winning, while a net premium seller had the 80% chance of winning. Once again be a net premium seller.

Good trading.

- Josip Causic