The Option Pit Method Trading Daily Options Expiration

The Option Pit Method Trading Daily Options Expiration Option Pit

What You Will Learn • Somethings about expiration decay • Trading daily expiration to express directional opinion • How One Can Use daily structure to create edge in spreads • How calendar spreads can be formed using daily options trading

Decay • Decay moves, as time passes at varying speeds depending on whether the option is ITM, ATM or a unit. • However, its nuanced • ATM is Exponential • OTM is Linear • Units take forever

Skew Curves

Skew Curve • Lets think about the skew curve and what it reveals to us as it gets closer and closer to expiration • How does the curve work as time passes? • When we are taught term structure we learn that under most circumstances it looks like this:

Term Structure § Notice that vol drops as we move closer to expiration (there is an exception for the 8 th because it has non-farm payrolls § However, when we look at skew structure the story is not exactly the same notice that IV’s are actually higher as we move away from ATM, where vega affects options more than the insurance value

Options

Curvature

Relative Value • The Week Before Expiration

ATM Call Spread • I can buy a 5 point vertical buying the 21502155 call spread for 2. 50 • The pay out is 1 to 1 – However it takes a while to pay out on this spread – At onset the spread only has a delta of 4 – THUS A 5 point move makes only. 04 * 100 * 5 – WOW 20 dollars!!!!!

Relative Value • The Day Before Expiration

ATM On the Daily • Lets look now at the 1 day trade • The Trade costs 1. 50 pay out is 2 to 3 not 1 to 1 – Trade delta is much greater than the even a week out – Delta is 18 thus. 18 * 5 *100 90 bucks on 150 bet!!! • AND DON’T FORGET THE GAMMA

The 5 Dollar Move • With Daily options the final move is actually more because of gamma • The gamma is exploding • Even better, the decay

Gamma

Decay • Decay is exploding every where, • the OTM option sold, if the underlying does nothing becomes worthless before 1 ET • The ATM retains value • Even if nothing happens it might be worth about 1. 50 or so

Building Spreads • Thus, the key to trading with dailys is to spread, not buy naked options • While the decay for the ATM option is explosive, the decay for immediately OTM options, options that were ATM on any other day other than expiration

Keys to Debit • For a Debit spread: – Buy an option near the money, At the money or in the money – Sell an option that is out of the money – Put trade on after 10 ET – Exit trade by 130 ET – Look at the Value on the 55 s – Look at the Value on the 70 s

• Notice that even with the 10 point rally, the 70’s expire with little value

Credit Spread • Sell an OTM option that would be an ATM option 2 days prior • Buy a cheapy option for protection with limited value • Execute trade before 10 AM ET • Exit trade by covering the short option – Leave the worthless long option to expire

What To sell

Targeting

P&L Targets • One should not be looking to ride these all day • These are targeted trades, look to make quick dollars • If the trade doesn’t work immediately, it might not be worth holding but CERTAINLY not into the last hour • Credit spreads should decay all of the ‘easy’ juice by noon or 1 PM ET, close them for a profit then

Butterflies • Butterflies allow for one to take even greater advantage of the ‘used to be an ATM option’ effect • When setting up the opinion – BUY ATM – Sell Former ATM – Buy Cheapy

Broken Wings • • • We love these for broken wings Gamma is exploding on the long Dying on the short Created cheap long or short delta Must not OVERSHOOT target Lets look at decay in delta

Trade Example • • BWB Daily SPX is 2160 on Fed day Buy 5 SPX 2165 calls for 1. 20 Sell 10 SPX 2170 calls at. 65 Buy 5 SPX 2185 calls for. 10 Fed rallies market Buy 10 SPX 2170 calls for. 10 Sell 5 SPX 2165 calls at 1. 25

Calendars • What is the major issue with a calendar spread? – When do stocks move the most? – When does that cause problems for calendar spreads? – What happens when a directional spread is TOO right? • Does the market price overnight gap risk properly?

Calendars • What if I could put on a calendar spread but NOT have overnight gap risk? • Imagine a scenario where I am trading around an event by owning vol, but trying to finance the trade?

Calendar

Calendar

Brexit • • OVERNIGHT Strangle: 14. 00 August Strangle: 85. 00 The Next Day S&P is: Up 35. 00 Trading calendars around these events can be deadly because of overnight and gap risk – Most moves happen overnight, NOT during the day – Those that DO happen during the day tend to be due to momentum

Daily Calendars • Setting up the S&P Calendar – Buy the anchor – Sell the daily option sometime near the open, wait 15 min to sniff out momentum – Close around 1: 30 -2 PM ET • Stay long the close – Reset the trade the next day

Daily Calendars • Trading in this manor will – Allow traders to capture gap risk – Allow traders to finance ideas, with out ‘breaking’ the concept – Requires more attention to the trade – Is more commission intensive – Overtime, will out perform standard calendar trades

Calendar advantage

Calendars • Daily expiration is going to change the way we trade calendars and look at decay • It going to allow for incredible strategic plays • Will invade equities soon which will open up better opportunities (equities have even crazier gap risk).

Summary • Decay is more nuanced than many people realize • Dailys will allow for spread trading • Dailys are incredible for fly's over long options • Calendar trading is going to change

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