How Theta Decay Works Over the Weekend
Oct 19, 2017
Of the infamous trading "Greeks," theta might be the most relevant to the tastytrade community.
Theta, as it relates to options trading, represents the amount of premium lost per day as an option moves toward expiration.
Purchasers of premium are hoping that an underlying makes a big move prior to expiration, while sellers of premium are hoping for the opposite. Statistically, the percentages skew (pun intended) heavily toward option sellers.
The chart below shows how theta typically decays over the life of an option:
For traders seeking to place directional exposure, positive theta positions can still be deployed. For example, selling a call in a stock you expect to go lower, instead of shorting the stock or buying a put.
The chart below, from a recent episode of Options Jive, illustrates how virtually every options position can possess either positive (collecting) or negative (paying) theta attributes:
Because theta is such an effective tool in a trader’s arsenal, the same aforementioned episode of Options Jive took a closer look at the "weekend effect" when trading options.
The discussion revolves around the fact that equity and option markets are open only five of the seven days in a week. If theta theoretically decays daily, the Options Jive team wondered whether it might be worthwhile to sell additional theta on Fridays, in hopes of boosting collections over the weekend.
The answer to this questions relates to the doubled-edged sword of option premium. Options possess premium because risk exists in the market.
In order to better understand the “weekend effect,” the Options Jive team examined the average movement in the market between Friday and Monday (i.e. over the weekend), from 2005 to present.
As it turns out, there is risk that exists over the weekend, because the standard deviation range for weekends (Friday to Monday) during the period studied was +/- 0.75%. The hosts basically extrapolated from the data that a given option’s premium already accounts for weekends.
Therefore, there doesn't appear to much advantage (if any) to deploying a strategy that focuses on adding theta just for weekends - for example, placing a trade on Friday with the intention of taking it off on Monday.
If your experience shows otherwise, or you have any questions about the "weekend effect,” we hope you'll leave a message in the space below, or reach out directly by emailing us at firstname.lastname@example.org.
We look forward to hearing from you!
Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.
Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.
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