Fear of volatility has created a big shift towards the options segment of the derivatives markets across exchanges globally. Post Lehman meltdown followed by other crises, traders and investors have been showing more confidence in options, which allow them to substantially mitigate the risks that financial markets have become so prone to.
Derivatives trading in India has expanded many folds amid financial inclusion, awareness generation and robust regulation.
Weekly options are entirely different than monthly options, and it behoves all options traders to know the key differences between the two types of options to avoid potential errors when placing trades.
Understanding Weekly Options
Weekly options were first introduced by the Chicago Board Options exchange (now branded as Cboe Global Markets) in 2005 with much excitement and anticipation. According to the Cobe website, “weeklys offer an innovative way for customers to efficiently take advantage of news driven market moves and short-term trading strategies.”
Prior to the arrival of weekly options, traders and investors only had 12 options expirations per trading year. Options expirations are a big deal for traders because, unlike stocks, options either expire in the money or out of the money at expiration. If options are ITM at expiration, they will have intrinsic value. If options are OTM at expiration, they will be entirely worthless. This black and white scenario is part of the appeal of options, and it is why there are so many options strategies to choose from.
Option sellers are hoping that the options they sell will either decrease in value prior to expiration or expire worthless (or both). Option buyers are hoping that the options they buy will either increase in value prior to expiration or expire with intrinsic value (or both).
Weekly options provide more flexibility and timeframes to choose from when deploying an options trading strategy.
Weekly options function virtually exactly the same as regular monthly options, except that they are created every Thursday up to 39 days in advance. Until recently, weekly options only used to be created with 9 days until expiration, but the CBOE evidently decided that wasn’t enough and opted to create them with more than a month until expiration to provide traders with more options (no pun intended).
Weekly options behave like monthly options in every respect except they only exist for eight days. They are introduced each Thursday and they expire eight days later on Friday (with adjustments for holidays). Investors who historically enjoyed 12 monthly expirations on the third Friday of each month can now enjoy 52 expirations per year.
Weekly options in Nifty index is the latest milestone in this arena. The weekly index options were launched in February of 2019 and have witnessed a meaningful rise in volumes. And it may be safely inferred that traders are getting inclined to such structuring of derivatives instruments. To be precise, weekly options allow better participation by traders in a particular binary event, where one is required pay low premium to get the binary advantage over monthly options in which premiums are high and gamma risk – i.e., the risk in long duration option contracts expiring in-the-money or out-of-money –- is extremely high.
Additionally, in the absence of any major event, traders can receive the premium by writing weekly option contracts. However, the receivable will be less compared with the monthly premium. At the same time, uncertainty or volatility of these contracts are low due to their short duration, which can help traders enjoy a premium with low, adjustable risk-reward ratio.
Another important advantage of weekly options is the utilisation of hedging strategies.
In uncertain times like the ones we are going through currently, an investor may get caught on the wrong foot in a particular Nifty stock because of a sudden negative development. To mitigate such overnight or weekly risks, one can get into a risk-reversal strategy by buying weekly Puts to take care of unsystematic risks.
Also, weekly options allow traders to structure their trades in a more enhanced way in options spread trading. For instance, when one is anticipating a moderate upside in a stock or the index, one can use a Call Spread strategy and buy weekly Call options at low premium and sell monthly contracts to receive higher premium, leading to negligible outflow. If the stock or index remains in the chosen strike range, traders can make decent profit by utilising the weekly contracts.
As volumes are ticking higher, we can extrapolate that the weekly index option market is going to make substantial contributions to the Indian derivative markets in the days to come.
Special Considerations
Virtually any strategy you can implement with the longer-dated options you can also do with weeklys. For premium sellers who like to take advantage of the rapidly accelerating time decay curve in an option's final week of its life, the weeklys are a bonanza.
Now you can get paid 52 times per year instead of 12. Whether you enjoy selling naked puts and calls, covered calls, spreads, condors or any other type, they all work with weeklys as they do with the monthlies, just on a shorter timeline.
Advantages and Disadvantages of Weekly Options
Advantages
In addition, during three out of four weeks, the weeklys offer something you can't accomplish with the monthlies—the ability to make a very short-term bet on a particular news item or anticipated sudden price movement.
Let's imagine it's the first week of the month and you expect XYZ stock to move because their earnings report is due out this week. While it would be possible to buy or sell the XYZ monthlies to capitalize on your theory, you would be risking three weeks of premium in the event you're wrong and XYZ moves against you. With the weeklys, you only have to risk one week's worth of premium. This will potentially save you money if you are wrong, or give you a nice return if you are correct.
Although the open interest and the volume of the weeklys are large enough to produce reasonable bid-ask spreads, they are usually not as high as the monthly expirations. The well-known pinning action that takes place in monthlys, where a stock tends to gravitate toward a strike price on expiration day, does not seem to happen as much or as strongly with the weeklys.
Disadvantages
There are a couple of negatives regarding weekly. First, because of their short duration and rapid time decay, you rarely have time to repair a trade that has moved against you by adjusting the strikes or just waiting for some kind of mean revision in the underlying security.
Second, although the open interest and volume are good, that is not necessarily true for every strike in the weekly series. Some strikes will have very wide spreads, and that is not good for short-term strategies.
Understanding Monthly Options
Monthly options were first introduced only in the form of put options in 1977 by the CBOE as a way to hedge long stock portfolios. Soon thereafter, call options were introduced and the world of options trading was born. Since then, options volume has exploded.
Although options originated as a form of hedging, a lot of traders now use options solely to speculate via buying or selling premium opportunistically.
Why are Options a Big Deal?
Basically, there are two different strategies traders use with options: buying and selling. In a nutshell, buying options involves risking a small amount of money to potentially make a lot, and selling options involves risking a large amount of money to hopefully make a little.
Traders like selling options, particularly out of the money options, because there is a higher probability that the option will expire worthless than that the option will expire in the money with some intrinsic value. However, in exchange for this higher probability of expiring worthless, selling options has a much greater potential for loss compared to reward.
It’s the age-old concept of sell high and buy low, except you don’t have to buy low if there’s nothing to buy when an option expires with a value of $0.00; this is part of the appeal of selling options.
As time passes and expiration nears, out of the money options contracts will theoretically decrease in value due to time decay. Without question, the Cboe realized that traders like to sell and buy options based solely on the amount of time remaining until expiration, so weekly options were created and there are now options expirations for most stocks every single Friday.
Final Thoughts
Besides weekly and monthly options, the only other type of option is “quarterly.” As you could probably surmise by now, quarterly options are appropriately named, because there are only four expirations per year. Since quarterly options are not that frequent, they are really not that popular.
A weekly option will never expire on the same date as a quarterly option. There is never any overlap.
At the end of the day, weekly options and monthly options are really similar, and the only difference, besides a few settlement times for different products, is the amount of time until expiration.
A lot of option sellers refrain from selling options with more than 100 days until expiration, because theta decay seems to have less of an effect with more time until expiration. Conversely, as expiration nears, out of the money options will rapidly lose value due to theta decay (because the option will either expire worthless or with intrinsic value), so this is precisely when a lot of option sellers choose to attack.
One thing to keep in mind is there is no “right” amount of time until expiration when choosing which options to trade. If you’re buying/selling options for a future binary event, like an FDA announcement or earnings report, make sure the event is set to take place during the lift of the option you’re going to trade. Other than that, selecting between weekly vs monthly options is entirely dependent on your market outlook and time horizon. Some traders want to express an opinion that the market will not go up/down beyond a certain price level, so they look to sell an option with a strike price that matches that level.
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