Weekly options: A more precise tool

September 15, 2017 08:30 AM

Short-dated options that expire on non-third Fridays, commonly referred to as Weeklys, were introduced by the Chicago Board Options Exchange (CBOE) in 2005. There was little attention paid to them and the volume in these non-standard contracts was modest. Five years later in May 2010, the first equity Weeklys were introduced on five different stocks. 

Presently, Weekly options are available for trading on more than 400 stocks, exchange-traded funds (ETFs), and equity indexes. Depending on the day, the percent of overall options volume that is attributable to Weeklys is anywhere between 35% to 50% across the CBOE option market (see “Growing week by week,” below). 

That chart shows the percent of average daily volume represented by Weeklys at CBOE from January 2011 to July 2017. In January of 2011, about 6% of the volume at CBOE occurred in Weeklys. At that time, there were only about 70 products (stocks, ETFs and indexes) with Weeklys available. As mentioned above, that number has grown to more than 400 products. In July 2017, 32% of volume at CBOE occurred in Weeklys, which was a tad lower than the record of 33% in October 2016.

Why Trade Weeklys?

 The core to the success of Weeklys relates to the time decay (Theta) nature of options. Theta measures the time value of an option, which dissipates at an accelerated pace the closer an option gets to expiration. Traders are either attempting to take advantage of time decay or they are trying to avoid it. Here are two examples of how traders may trade time value. First, is an example of how short-dated options that are in-the-money or have intrinsic value, and how they may be used to trade a short-term outlook for a stock. 

When a trader purchases a call or a put on a stock, the trader will most likely need the option to move in their favor before the option value approaches a break-even price. This extra price move that is required to reach the break-even price relates to the time value added to the options’ intrinsic value. Consider if Apple (AAPL) is trading at $157.25 and in traditional monthly options.
To take a bullish position on AAPL a trader purchases an AAPL 150 call at $10 that expires in a month. The payoff for this option at expiration is shown in “Apple monthly,” right). Note the break-even price for this trade is $160.

Now consider the same situation, but with available Weeklys. A one-week AAPL 150 call could be purchased for $8. This means the break-even on the trade is a little lower at $158. Therefore, if this trade is held until the expiration of the option, the stock only needs to rise 75¢ to break even. Also, since there is very little time value in the option, this call will more closely resemble that of the stock performance (see “An apple a week,” right). 

On the second AAPL payoff diagram the stock only needs to move up 75¢ to reach a breakeven point as opposed to $2.75 in the case of the one-month option. Before Weeklys were available on stocks, a short-term bullish outlook on a stock did not necessarily make sense as an option trade. The option price would not replicate a move in the stock as well as a trader would hope due to the amount of time left until expiration. Also, the cost of an option may have involved too much time value to make an option trade an attractive alternative to purchasing a stock. 

The decay of time value of at-the-money options tends to accelerate as expiration approaches. Before Weeklys were available there were traders who would only get involved in the option market during expiration week to take advantage of this sort of option price behavior. As an example of this sort of time decay behavior, consider the iShares Russell 2000 ETF (IWM) trading at $135 with five trading days remaining until expiration. A five-day IWM 135 call is trading at $1.45. Five days later this option expires and if IWM is at or below $135, the option will have no value. “A Theta play,” above) shows the expected time decay for this 135 call, using the assumption that the underlying price does not move at all.

Note the dramatic drop in the value of this at-the-money call that occurs during the last week of life for this option contract. Even more impressive is the drop in the last day or two, which is the type of time decay that would only show up once a month for traders to take advantage of in the past. Now they have the chance to benefit from this dramatic loss in option value through selling at-the-money options on a weekly basis instead of just once a month. 

One of the greatest benefits of options over an outright stock or futures contract is the ability to take a more precise position based on where a trader believes the market will go, or not go, and when. Weekly options drill down a little further, allowing traders to take even more precise positions.  

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