Options contracts have been around for hundreds or possibly even thousands of years, but the modern exchange-traded, standardized options have only been in existence since 1973.
Starting with calls - puts were added in 1977 - the Chicago Board Options Exchange (CBOE) introduced options contracts on stocks with uniform terms that simplified transactions.
Instead of negotiating the size and time frame of every contract, buyers and sellers could now make transactions in options contracts that all had the same size and expired on the third Saturday of each calendar month. The establishment of the Options Clearing Corporation also gave traders the confidence that the terms of the contracts would be honored and that there was no counter-party risk.
Volumes soared as all sorts of traders and investors realized that options perfectly met their desire to transfer risk, either to hedge or speculate. The Options Clearing Corporation now clears in excess of 20 million contracts per day.
When trading began to migrate from open-outcry trading floors to electronic exchanges and most trades were no longer executed in person, the number of options that could practically be listed expanded significantly. In addition to the traditional monthly options, there are now options expiring weekly on almost every US equity.
Should you be trading “weeklies” instead of the old-fashioned monthly options?
Maybe…but only if you understand a few significant differences.
If you have a specific event in mind and want to make an options trade based on your expectations, weeklies will often be the best way to create a position with the specific risk/reward profile you desire.
When options have less time to expiration, the greeks associated with them change dramatically. If there’s a possible event next week and you are choosing between an option with 8 days remaining and an option with the same strike price and 36 days remaining, the shorter-dated option will have more gamma, more theta, less vega and less rho.
Here’s why:
Gamma is how much an option’s delta changes when the underlying moves. With less time to expiration, options that are in-the-money or out-of-the-money are more likely to stay that way because there’s less time for the stock to move significantly up or down. If the underlying does move, options deltas changes quickly.
Theta rises as well because all the remaining time value left in options has to go to zero at expiration. (No time remaining = no time value.) Any given option might or might not have any intrinsic value at expiration, but no option will have time value. The amount that an option loses in value each day rises as a function of the square root of the number of days left to expiration.
Vega drops as an option nears expiration because a change in implied volatility won’t change the value of an option very much. Even if expectations for the volatility of price movement in the underlying increase, there’s simply not much time left during which a significant move can happen, so the options don’t gain much value.
Finally, we don’t generally pay much attention to an option’s sensitivity to interest rates these days because of the low and stable rate environment, but shorter-dated options have less rho than longer dated options. With just a week or two remaining, an option's rho is so small that it can be safely ignored.
Practically, all this means that if you choose shorter-dated options for your strategy, implied volatility and interest rates matter very little (or not at all) and the success or failure of your strategy will rest mostly on movement in the underlying and the passage of time. If your intention is to make a leveraged bet on a big expected move (or conversely, on the lack of a move) you’ll get more bang for your buck from weekly options.
Keep in mind however that the factors that hurt your position will hurt more acutely as well.
One final consideration: weeklies are sometime much less liquid than the traditional expirations. This means you might pay a wider bid-ask spread to initiate a trade and you might find the trade more difficult to close efficiently if you decide to exit before expiration. It always makes sense to look at the width and quoted size of both the weekly expiration you’re considering and compare it to the closest monthly expiration to get a sense of their relative liquidity.
-Dave
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