What about Weeklys?

From a reader:

What about the weeklies (naked puts and calls). The time span is very short and if you are more conservative, you can skip the weekends and start on Monday and bet on about 4 days. You can still get about 10% return with very little risk.

Hi Frank,

Good question.

When I trade Weeklys, I do start the trade on Monday and typically exit Wed or Thurs. I look to earn 30 to 40 cents on a 5-point index iron condor. The initial premium tends to be in the vicinity of 80 cents.

These options are reasonably far OTM. However, the sales are not naked short like yours. The fact that you prefer to sell naked options changes the risk profile:

    –You do not buy protection, so your short option is much farther OTM than the one I sell. That increases the chances you will have a profitable trade.

    –Your potential loss is gargantuan. I agree that it will not happen often, but in my opinion, it happens often enough to make the sale of naked options too dangerous.

If you do not get overconfident and trade this strategy in small position size, then it can be viable for the account of an experienced trader. Why experienced? Because risk management is the key to the trader’s success.

The trade

If we sell a low-delta, far OTM option, collecting 10% of the margin requirement; or, if we sell a 5-point iron condor for $0.50 – then we have an opportunity to earn that 10%.

To earn 10%, we must allow the options to expire worthless. That involves extra risk because each day comes with the tiny possibility of market-moving news.

I know that works for many traders, but I never do that. I prefer to eliminate all risk one or two days early and avoid overnight risk for that extra day. So I would be happy to pay 20 cents in the above scenario, reducing profits to a still very acceptable 6% before commissions.

Risk

We can look at risk as the probability of losing money and I agree that the probability is well on our side.

We can also consider risk to be the money at risk, or the sum that could be lost. That is how I prefer to think about risk.

From your perspective, risk is low. From mine, it is very high. So is this high risk or not? The answer must be an opinion based on fact, but remains an opinion. That means intelligent people can disagree.

For me, short-term options come with far too much negative gamma. Translating that to English for the newer option traders: When we sold an option or spread that looks and feels ‘safe’ because it is somewhat far OTM, when time is short, it does not take much of a move in the underlying asset to push that short option ITM. And that is the high risk of which I speak.

When we collect a small cash credit, the potential loss is high. The problem is that too many rookies traders do not know how to react. Some exit far too early in a panic. Others sit frozen with inaction and wind up taking the maximum possible loss.

Earnings Potential

Id you can earn 10% per week and compound those earnings, after one year, $1,000 would become $142,000. I’m sure do not expect to win every week, but I hope that you recognize that it is impossible to earn such reruns with low risk.

My conclusion is that your plan is fine for the experienced, disciplined trader who is skilled at managing risk. However, it is far too dangerous for the inexperienced trader.

One Response to What about Weeklys?

  1. Konsta 05/15/2013 at 2:06 PM #

    “5-point index iron condor”: Does 5-point mean that the body of the condor should have a 5-index-point-width?

    Clarification: a five point-iron condor has a call spread that is 5-points wide and a put spread that is five points wide.
    The distance between the calls and puts is immaterial.

    Example:
    Buy 10 XYZ Nov 220 put
    Sell 10 XYZ Nov 225 Put

    Sell 10 XYZ NOV 300 call
    Buy 10 XYZ Nov 305 call/