Weekly Options: The why and the how

Specifications and Settlement

Weekly options expire in approximately one week and have contract specifications identical to those of regularly listed monthly expiration options. The exercise style for weekly options is the same as for standard options on that product. Equity and ETF options are physically settled, with index options being cash-settled.

Options exchanges can list up to five consecutive weekly expirations for selected securities. Weekly options usually expire 4-5 weeks from the time that they are listed, with the last trading day on a following Friday. No weeklies expire during expiration week for standard options (third Friday of each month). Weeklies are not available for all option classes.

A full list of weekly options on U.S. equity option exchanges can be found here.

Users of non-weekly US equity options may be familiar with settlement issues, although many investors may be keen to avoid exercise. Some weekly index options have a last trading day of Thursday and will be cash settled on Friday morning (AM). Others may have a last trading day of Friday and will settle in the afternoon (PM). Please visit the website of the exchange which is trading the product for exact contract specifications. AM settlement may add the risk of overnight movement of the underlying instrument before the settlement price is known, whereas PM settlement allows for trading right up to the close of trading. Nevertheless, a short option position still has unknown assignment risk until the clearing firm holding the trade provides notification.

See more specification details here.

Typical Strategies

Because of the proximity of expiration, buyers are attracted to the low relative cost of hedging or positioning, albeit for a short period of time. Sellers are interested because of the rapid time decay which occurs in the last days of an expiring weekly option.

Short duration makes the "Greek" measures of delta, gamma and theta very important in pricing and risk analysis. Delta measures the sensitivity of the option price to a movement of the underlying’s price. Gamma measures the expected change in the delta to a change in the underlying stock price. Theta measures the expected change in option value with the passage of time (time decay).

Harvesting time decay can offer opportunity for investors. Covered calls and cash secured puts are two possible strategies. Iron condors are another. One of the main threats to benefitting from time decay is a rise in volatility. High priced stock with high volatility may offer better returns – but also a higher risk. A weekly option is a short-term strategy, with little time for adjustment.  

Cash Secured Put

In this example, the investor writes an at-the-money put, anticipating little change in the underlying price. He hopes that volatility stays the same or declines, allowing him to benefit from time decay. The downside risk is that either the underlying stock price declines and the short put is assigned and/or volatility picks up and the option increases in value. Because of the possibility of either of these events, we have selected a cash secured put, ensuring that the investor has enough funds to buy the stock if the short put is assigned. If the option is not assigned, then the investor is left holding cash. Remember also that the short put position could be exercised at any time.

Covered Call

A covered call has a similar motivation behind it. Again, the investor believes that the underlying stock price will stay at current levels and that volatility will remain low so that she can benefit from time decay. Just in case she is wrong, however, she is holding the underlying stock against the call option that she has written. Again, the short call position could be exercised at any time. If the stock breaks to the upside, or volatility picks up, or both, she has the stock to deliver. If the stock price and volatility stay unchanged and the option expires worthless, then she will still be holding the stock. The downside risk for the investor is that the underlying stock price declines below the purchase price for that stock. 

A short condor can be seen as being short a strangle and long an even wider strangle. It could also be considered as a bear call spread and a bull put spread. In the above example it is comprised of the following positions:

Long 1 XYZ 70 call
Short 1 XYZ 65 call
Short 1 XYZ 55 put
Long 1 XYZ 50 put

The investor is hoping for the underlying stock to trade in narrow range during the life of the options. The strategy profits if the underlying stock is inside the inner wings at expiration.

The investor hopes the underlying stock will stay within a certain range by expiration. An increase in implied volatility, all other things being equal, would have a negative impact on this strategy, but the passage of time will have a positive effect.

The strategy involves both long and short positions. The short options that form the shoulders of the condor's wings are subject to exercise at any time, while the investor decides if and when to exercise the wingtips. If an early exercise occurs at either shoulder, the investor can choose whether to close out the resulting position in the market or to exercise the appropriate wingtip.

The maximum gain would occur should the underlying stock be between the lower call strike and upper put strike at expiration. In the example above, the maximum gain will be when the underlying price at expiration is between the short 65 call and the short 55 put.  

In that case all the options would expire worthless, and the investor would retain the premium received to initiate the position. 

The potential profit and loss are both very limited. In essence, a condor at expiration has a minimum value of zero and a maximum value equal to the span of either wing. An investor who sells a condor receives a premium somewhere between the minimum and maximum value, and profits if the condor's value moves toward the minimum as expiration approaches. This strategy breaks even if at expiration the underlying stock is either above the lower call strike or below the upper put strike by the amount of the premium received to initiate the position.

Conclusion

Weekly options offer attractive possibilities to investors. Their specifications are the same as for longer dated options, but with an earlier expiration, which leaves little time for adjusting a position. Long call or long put positions – according to the market sentiment of the investor – are generally cheaper because the option is short-dated. For investors working from the short side, they hope that the underlying price is unchanged, and that volatility remains unchanged (or lower), allowing them to benefit from accelerating time decay.

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