Tips For Trading Options In Expiration Week
Expirations Week Adds Volatility
Expiration Week Brings Volatility To Options Markets
Trading options during expiration week can be tricky. Often called "witching hour", expiration week brings an extra amount of volatility to the market. The volatility is a natural result of market functions as traders unwind their long and short positions moving cash through the system. In order to trade options without getting an ulcer you will have to learn to recognize and prepare for expiration week as a part of your trading system.
What Is Volatility?
Volatility is important to the markets and trading. It is the measure of how much the market moves and is neither positive or negative. When the markets are trending quietly and trade in a tight range volatility is said to be low. When the market is really moving and makes big leaps from one day to the next volatility is said to be high. These movements can be up or down and can take the markets to highs or lows or keep it in a trading range, bouncing from support to resistance.
The Volatility Index
A volatility index is a measure of the relationship of the price of options to the price of the underlying stock or index. The are many but the most commonly used is the VIX. This is the S&P 500 Volatility Index. It is used as a trading tool by telling traders when options are cheap in relationship to their stocks and vice versa. By inference this relationship is seen as a gauge of fear; when options are cheap the market is calm and when they are expensive the market is fearful. It is even possible to trade options on the volatility index.
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Number One Tip For Trading Options In Expiration Week
My number one tip for trading options in expiration week is don't, unless it coincides with a plan or strategy you are already using. Trading is a risky business and simply trading in expiration week because it is expiration week is not a good strategy.Everything I have been taught or learned on my own over the last ten years of trading is that good trades are based on sound analysis and good techniques, not expiration week. If it happens that a trade opportunity arises during expiration week it would be wise to take it into consideration; It may even be a reason to wait until the next week.
- Have a strategy and stick to it. It should incorporate fundamental and technical analysis with money management and position sizing.
- Always check your positions when it is expiration week. Never let anything just sit when you should be locking in profits or cutting losses. There is no reason to leave money sitting on the table waiting for a position to expire.
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Should I Buy Back My Covered Calls In Expiration Week?
Many traders new to covered calls ask me this question. Should I buy back my covered calls in expiration week. I actually have two questions of my own for answer.
- Is your covered call in the money? If so then you should not buy it back. If your covered call is in the money you are earning the maximum return for the trade. You will have to sell your stock but if you were to buy back the options you could end up losing much more than your calculated potential loss.
- Is your covered call out of the money? If it is out of the money you could buy it back but you don't need to. The options will expire worthless, you will keep your stock and you can then sell more covered calls against in the next month.
How To Trade Options In Expiration Week
Under ordinary circumstances new events can send a stock higher or lower. The added volatility of expiration week can make these moves more extreme, providing trading opportunities. There are many different types of news events that can move the markets. Checking the calendar each week to see what important releases are scheduled. In addition to news it is also possible to use technical strategies that follow market momentum or buy/sell pressure.
- Economic Data - economic data is a big mover of the stock market. Domestic and international economic data are often the catalyst for big short and long term movements.
- Corporate Data - corporations must file regulatory documents on a scheduled basis. Sometimes these releases are market moving and sometimes they coincide with options expiration week.
- Technical Indicators - Technical Indicators like the Put/Call ratio can be very telling during options expiration week. The put/call ratio is the relationship between the number of puts in the market to the number of calls. When the ratio is over 1 there are more puts. If the number gets to an extreme, meaning there are an unusually high number of puts or calls, it can signal a reversal.
Pattern Day Trader Rule
If you are going to be trading options during expiration week, or on any short term basis, you need to be aware of the Pattern Day Trader Rule. The Pattern Day Trader Rule, or PDT, was adopted by the SEC with the recommendation of the major stock exchanges following the Dot Com Bubble of the late nineties. The PDT rule is meant to keep unwary and unscrupulous traders out of the markets but has wide ranging affects. Basically, the rule states that any person who buys and sells the same security in the same day, 3 or more days out of 5 consecutive trading days is a Pattern Day Trader. Once you have been identified as a PDT you will be required to maintain a margin account, in addition to some other requirements, in order to trade options.