SMB CAPITAL OPTIONS TRAINING PROGRAM

Expiration Week Plays

SESSION SIXTEEN

Most options expire on the third Friday of each month (other than weeklies)

There is a tendency for options to dramatically lose implied volatility on those days-often 2-3% or more.

If you enter into a vega negative trade during this period, and the market is relatively calm, a 10-12% gain from 10:30-3:00 is entirely possible.

However, gamma is very high during these periods and therefore a big move in the market can cause these trades to go bad very quickly.

Expiration Thursday Plays

The basic concept is to find quiet vehicles with lots of extrinsic value left in the ATM options in order to take advantage of crush of volatility and theta which is coming out so quickly on expiration Thursday.

Stocks, indices or ETFs, should be reasonably high priced so that commissions are not too large a percentage of the return. (AAPL, GOOG, BIDU are commonly used).

High Option Volume is important to assure liquidity. Avoid any stock with news or earnings coming up on expiration

Thursday or Friday. Avoid stocks with low extrinsic value of the ATM options. The

whole concept is to trade the “juiciest” possible options for a very short period of time.

Anything that has had wild price action in the last week should be avoided.

Screening for the initial trade

Very high negative vega is best. Very high positive theta is also important. Trade should be positioned delta neutral at

inception, unless trader has a thoughtful bias.

Acceptable Gamma Risk. That can be defined as

Theta +(Expected IV collapse*Vega)/Gamma>6.

Measure a one Standard Deviation move and if the expected delta and gamma effect of such a move would overcome the theta/vega coverage then the trade should be avoided.

Underlying price near a strike.

Selecting amongst candidates

Avoid placing trade until at least 10:30 AM as the market needs to settle.

Trades must be monitored all day. Set alerts at 10-12% profit. Max Loss normally will be 20%. This will

normally be caused by delta and gamma overcoming vega and theta.

Prudent to exit the trade by 3:00 EST as often the final hour can get very directional creating problems.

Place iron butterfly ATM

This is a trade that can appreciate so quickly that it often does not involve adjustments, however

If the trader wishes to cut deltas, buying back credit spreads on the threatened side of the trade can be utilized. This is done through buying enough debit spreads to achieve the delta reduction that is being sought. This will widen the tent.

Adjustments during the day

AAPL expiration Thursday trade, February 2011

Trade initiated at short strike

Risk graph at inception

IVs drop, adjustment made

IVs continue to drop.

1 PM, IV drop continues

Trade exited at small profit

There is a documented tendency of certain stocks to gravitate towards a strike price with a high amount of open interest on expiration Friday.

There are many theories, but none conclusively proven.

An iron butterfly trade is commonly utilized as the best way to take advantage of the extreme theta of the final day of expiration (at the money and very little vega).

Expiration Friday Pinning Trades

You want it to be very quiet. No earnings or news or recent radical price movement.

You want stocks that have a history of pinning. That is the biggest predictor for success.

If the market itself is too strong the trade must be called off.

Candidate Selection

Trade is initiated when it appears that the market is gravitating towards (pinnning) on a strike and settling down around that strike. This often happens late morning or early afternoon. Never trade in the first hour.

If the market is heading in one direction and the stock is heading in another, it may be a sign that the stock is trying to pin to a strike and ignoring the market direction.

Trade entry

Trade can be adjusted, like expiration Thursday trades, by buying back threatened shorts or full credit spreads to cut deltas.

Vol spikes in the middle of the trade may force adjustments and are dangerous.

Exit by 3pm to avoid late afternoon drive in the market.

Target profit—15-20% Max Loss-20%

Trade Adjustment and Exit

GOOGLE FEBRUARY, 2011 Expiration Cycle

GOOG at open 2/18/11

Note highest open interest

Stock gravitates to 630 strike

Continuously hovering around highest open interest strike

After 1 hour pinning near 630 we execute iron butterfly

Breakevens 628-632

30 minutes into trade, short time premium evaporating

60 minutes into trade, up 10% pinning continues

90 minutes, pinning continues , as does theta deterioration

Trade finally exited for gain of 28% in 2.5 hours, as GOOG pinned to 630

Choose some stocks from the following list and observe them over the past six months after the close on expiration Wednesday using Optionvue’s backtrader module: AAPL,APA, DVN, FDX,GS, GOOG, LMT, MA MON, RIG, SHLD,X, BIDU, MCD. Select two stocks that meet the criteria of an expiration Thursday trade and place an iron butterfly at the appropriate time on the corresponding Thursday.

Choose some stocks from the list above and observe them over the past six months on the first hour of expiration Friday using Optionvue’s backtrader module: Select two stocks that meet the criteria of an expiration Friday trade and place an iron butterfly at the appropriate time on the corresponding Thursday.

Mark down results.

Homework