My general premise – often repeated – is that it is less risky to trade options with longer, rather than shorter lifetimes. True, shorter-term options come with more rapid time decay, and that is very appealing when using strategies in which we earn our money from that time decay. However, shorter-term options are, or may soon become, loaded with negative gamma.
With that increased negative gamma comes an increased chance of losing a lot of money in a hurry. The intelligent and conservative trader does not sell naked options, but even call or put credit spreads can appreciate in value very quickly when the options we sold become ATM or ITM.
Call credit spread: A position in which the trader buys one call and sells another. The option sold has the higher delta and the higher option price (premium). Both options expire at the same time and are on the same underlying asset.
Put credit spread: A position in which the trader buys one put and sells another. The option sold has the higher delta and the higher option price.
Longer-term options have less gamma, and undergo a more moderate delta change as the underlying stock moves. Thus, when the stock rises or falls, credit spread traders have more time to react (exit or make a risk-reducing adjustment). Profits are earned much more slowly because time decay is far slower for longer-term options.
If Weeklys appeal to you, I recommend trading small position size. These puppies come with higher-than-usual risk, regardless of whether you buy or sell them. It is the increased rate of loss that makes the short-term position so dangerous to hold.
Of course, we don’t have to sell Weeklys or any other option. We can opt to purchase them. The risk here is that the options will decay too rapidly, and if the anticipated move in the stock price does not occur quickly, there is little time for recovery. Buying these Weeklys is truly a hit or miss proposition.
Mark D. Wolfinger
Options involve risk and are not suitable for all investors. Click here to review the Characteristics and Risks of Standardized Options brochure before you begin trading options. Options investors may lose the entire amount of their investment in a relatively short period of time. Online trading has inherent risk due to system response and access times that may vary due to market conditions, system performance, and other factors. An investor should understand these and additional risks before trading. Multiple leg options strategies involve additional risks and multiple commissions, and may result in complex tax treatments. Please consult a tax professional prior to implementing these strategies. While Delta represents the consensus of the marketplace as to the theoretical price movement of the option relative to the underlying security, and Gamma represents the consensus of the marketplace as to the theoretical rate of change of Delta relative to the underlying security, there is no guarantee that these forecasts will be correct.
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