Weekly Options – How and When To Use or Avoid

Recently, the use of Weekly Options has generated more SaferTrader.com “how and when to use” questions, emails and members-only Forum commentary than most other subjects.

In this “white paper,” we’ll look more closely at the opportunities and pitfalls associated with this intriguing investment instrument.

The Appendix at the end of this article provides a list of all currently available weekly option instruments.

A Peek Ahead: There are some excellent conservative-investor uses for weekly options, but while they offer great benefits for some types of investments, they should be avoided for others. We’ll review the how, when, and why they may fit your objectives.

Quick Review of Mechanics

1. Weekly options began in 2005, utilizing the S&P 500 as the underlying. It wasn’t until 2010 that weekly options on individual stocks were made available at various exchanges.
2. Weekly options are now available on many indexes, ETF’s, and individual stocks. The list is growing. The list of “availables” as of early 2012 appears in the Appendix of this “white paper” article.
3. Weekly options begin trading on Thursdays, and expire the Friday a week later (an 8-day life span). But they are not offered for the final week of trading of regular monthly options since the values of the weekly and monthly options would be identical during the final week before expiry.
4. Both American-style and European-style options are available. American style can be exercised at any time; European-style only on expiration day. As with regular monthly options, weekly options can be bought or sold at any time prior to expiration.
5. The liquidity of weekly options is a significant issue. Typically weekly option volume is about 10% of the total option volume of the underlying. The significance lies in the fact that lower trading volume equates to wider bid-ask spreads and therefore more slippage when entering or exiting a trade.

Time is of the Essense

Not surprisingly, “time” is the key to when weekly options confer benefits vs. when the weeklies should be avoided.

1. Weekly options operate in the environment where the time decay curve is at its steepest, i.e. the time decay an option undergoes is not uniform. Value erodes most rapidly as we near expiration.
2. The fact that time value is disappearing rapidly as an option approaches expiration is beneficial if we are buying out-of-the-money weekly options because the premium we would need to pay for extrinsic (time) value is already in sharp decline.
3. Conversely, sellers of options (income seekers like “The Monthly Income Machine” folks) may not be offered a worthwhile premium on weekly options unless they accept closer to the market strike prices. That problem is compounded by the fact that the markets, on balance, are making increasingly large daily movement. In some years (e.g., 2008, 2011, 2020), the S&P 500 underwent greater than 2% daily swings in value on fully 15% of trading days, but in some years less than 9% of the days.

Advantages of Weekly Options

In general, statistics for options buyers are pretty grim. Most out-of-the money (OTM) options expire worthless, resulting in most outright buyers of OTM options losing money over the long run, regardless of monthly or weekly options. However, there are specific situations when outright purchase may be a viable approach:

1. Cheap Insurance in connection with an “event.” Earnings reports and other “known” events can produce very large price swings when they occur. Because time decay continually erodes the value of options, you can hedge a stock (or an option position of any kind) at low premium cost for a short time with a weekly option. You would buy the weekly calls or puts – in the opposite direction of your position being protected – for the week that overlaps the expected announcement or event date.
2. Speculative Outright Position. If what is sought is a speculative gamble on the outcome of an event, i.e. a “directional” trade, the weekly option that overlaps the event will offer a lower premium cost than a monthly or quarterly option purchased earlier. Again, this is due to the fact that you need to pay for much less time.
3. Reverse Iron Condor. Basically, this approach involves two spreads like an income-oriented Iron Condor, but the spreads are “debit” spreads because your near strike price for each spread is “long” and the more distant leg is the short. Your account is debited the net difference on each Reverse Iron Condor spread, rather than being credited as with a regular iron condor. Using weekly options for Reverse Iron Condors makes sense because, once again, the premium is significantly smaller since there is less time to expiration. Since this is a debit spread, you want to pay as little premium as possible.

Disadvantages of Weekly Options

The disadvantageous factors associated with weekly options are essentially corollaries of their advantages.

1. Weekly Options Not Advantageous for Credit Spreads

The underlying rationale for credit spread strategies like “The Monthly Income Machine” is to provide the conservative income-oriented investor with a vehicle that can produce substantial reward with substantially less risk than other approaches.

It is based on receiving profit (premium), garnered from option buying speculators, by selling them the time they need for their options speculations.

Bottom line, credit spread investors want to collect that premium built into the out-of-the-money options price that is based on “time remaining to expiration.” On appropriate underlying stocks, ETF’s, and indices, that premium can be substantial even at strike prices quite distant from the current market.

It follows, then, that weekly options offer a lot less premium value for the option seller to gain than he could earn by earlier selling of monthly ones because there is so little of the time built into the weekly option’s life.

Typically, the only way to collect a really attractive premium selling a weekly option is to use strike prices that may be dangerously close to the current market.

2. Other Potential Disadvantages to Weekly Options

The Fun Factor. While the “action” provided by weekly expirations allowing for more trades throughout the month may be a dubious benefit for the thrill-seeker, it can represent a potentially dangerous temptation for conservative investors to over trade their accounts.

Commission Costs. Obviously, brokerage firm adoration of weekly option traders is surpassed only by their love for day traders. While commission costs nowadays are quite reasonable at option-friendly brokerages, making 3-4 times as many trades/month makes even a small account very profitable for the brokerage house… but not necessarily for the trader.

Wider Bid-Ask Spreads. As noted earlier, weekly option volume and open interest are considerably less than for monthly options. Consequently, you are likely to be dealing with considerably more price slippage when entering or closing out a trade because less active options involve wider bid-ask quotes.

Theta Risk. Theta, you will recall, is the “Greek” indicator that measures the rate of option value decay as time passes. The rate of time decay premium value erosion accelerates explosively as options nears expiration… and with weekly options, that increasing loss of value is already underway when the position is established, and keeps accelerating every hour from that point. This is clearly a detriment to the option seller.

Conclusion

Weekly options are best employed when we particularly want to be in the game during an upcoming known event and want to speculate on the outcome.

The advantage of using weekly rather than monthly options when buying puts or calls for this purpose is that there will be less premium cost than monthlies bought earlier; as we’ve discussed, option premiums are very dependent on the amount of time remaining before option expiration and the option buyers can pay less premium because there is less time left until expiration.

From the standpoint of collecting premium, as with credit spreads, the reverse is the case. The monthly options will offer the option net seller more premium than the weeklies – at the same price of the underlying stock, index, or ETF simply because the additional time to expiry confers additional premium value.

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Lee Finberg
Options Income Specialist –
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Note: We can – and do – guarantee your satisfaction with “The Monthly Income Machine” detailed how-to blueprint for conservative income investors. No one, however, can guarantee market profits. For a full description of the risks associated with such investments, see Disclaimers.