Trading Options Near Expiration

This post was recently published at Options Zone, with the clever title: How
to Avoid the Wrath of Gamma at Expiration
.


When it comes to trading near expiration, there are almost as many opinions about what to do as there are traders.  I'm a strong believer that it's best to avoid holding any positions into expiration, but that's especially true for short positions.

The rapid time decay and the thrill that comes with watching options (that you sold) expire worthless, makes it very tempting to hold onto short positions.  Part of the time it just feels like a waste of money to pay $15 to $25 for an option that is 'obviously' going to be worthless next week.

More than that, when an option is out of the money by a small amount – perhaps 2%, it's tempting to look at that wonderful ticking clock and count how much you are making every hour.  Ah yes, beautiful theta is a joy forever.

Alas, options with positive theta come with negative gamma.  For the option short, you can describe theta and gamma:  "It was the best of Greeks; it was the worst of Greeks."

Nothing results in larger accelerating losses than owning positions with negative gamma.  Watching the stock race from being out of the money to moving into the money can be a paralyzing experience.  We all 'know' that this cannot happen to us and that each of us would simply buy back the options before it became a problem.  If you've never been there, if you've never watched an option move from $0.25 to $1.00 in a heartbeat, then you just don't get the situation.  

If you didn't want to pay a quarter, how in the world are you going to convince yourself to pay a buck?  And while you are trying to pull the trigger, the option is now priced at $1.25 and then $2.  Stubborn now, there's no chance you will decide to pay that 'outrageous' price.  Convincing yourself that someone is manipulating the stock price as expiration approaches, you do nothing.

Sometimes this stubbornness is rewarded, and the stock stops its movement and retreats.  Perhaps a rumor drove it higher and the denial is lowering the stock price.  The problem with being rewarded in this situation is that no lesson is learned and next time you may not be so lucky.

At other times, this is just the beginning.  The next morning the stock opens higher and keeps on moving.  At some point the pain is too great and you cover.  Is that $4 per option, $6? Who knows.  But it doesn't matter.

What does matter is that you were so in love with positive theta that you ignored its partner, negative gamma.  That particular Greek does not like to be ignored, and every so often gamma rears its head and takes no prisoners.

In my opinion, the risk of holding short options into expiration far outweighs any potential rewards.


The Other Side

Of course, there's another side to the story.  Jeffrey Augen wrote an entire book based on the idea of teaching his readers how to Trade Options at Expiration.

 
Augen book

Trading Options at Expiration: Strategies and Models for Winning the Endgame

For the right trader, these methods are worthwhile.

One thing is certain, whether you buy or sell options, trading near expiration can be exciting or frightening – or both.

664


Lessons_Cover_final


Lessons of a Lifetime

Now available in KINDLE format

 


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2 Responses to Trading Options Near Expiration

  1. henry Tzuo 04/16/2010 at 5:50 AM #

    Thanks Mark — personally I don’t do it — because it is too dangerous. when it is close to exp, the behavior of op will be like futures (for index and all other ops, this is true — for stock options, there may not necessarily be stock futures.). Therefore, it is not exactly a “pure” option anymore. Maybe a more pramatic strategy is to build positions in the coming month.

  2. Mark Wolfinger 04/16/2010 at 7:21 AM #

    Henry,
    I also prefer to get out of very short-term options to play in the more distant sandbox.
    But the majority go for the thrill of playing near term gamma.
    Regards