Over the last few months I have put forth a number of option strategies. Most of these strategies have utilized weekly options as one of their components. Many readers have asked when to use weekly options and when to use monthly options. In deploying any strategy that includes either a weekly or monthly option it would be helpful to understand their relative merits and then set guidelines for implementing the option strategy.
Option premiums can be broken into two parts. The first part, or intrinsic value, is the amount an option is "in-the-money." For example, assume a stock is selling for $50 and you have a call with a strike of $45 and a premium of $6.50. Well, $5.00 of the $6.50 represents the intrinsic value. This is the “built in” value of the option, the amount that "belongs" to the owner of the call. The remaining $1.50, the extrinsic value, represents the “uncertainty” value of the option.
All options consist of 100% extrinsic value if they are "at-the-money" or "out-of-the-money." As the underlying stock moves in a direction that goes in-the-money, intrinsic value gradually replaces extrinsic value. When the option is very deeply in-the-money, it may consist of almost 100% intrinsic value.
When buying an option the objective is to pay as little for extrinsic value as is possible. When selling an option the object is to capture as much extrinsic value as possible. Of course, this must be modified by the overall strategy objective.
Let’s assume an option strategy consisting of selling "at-the-money" cash secured puts. Additionally, let’s look at two distinctly different stock characteristics: a low beta stock and a high beta stock.
The low BETA stock is easily represented by the SPDR S&P 500 ETF (NYSEARCA:SPY).
As of this writing SPY is trading at $125.48. Since the strategy is to sell options, the objective is to receive as much premium over the time frame as possible.
The closest at-the-money put option, with 100% extrinsic value, is the $125 strike. The November 11th weekly option premium is $1.47 and the December 17th monthly (five weeks) has a premium of $4.40.So which one should we choose?
Given a time frame of five weeks, if weekly options could be sold at $1.47 per week, they would total $7.35. This is 67% greater than the monthly option and, apparently, the clear winner. But, this assumes nothing changes and the risk remains relatively the same over the five weeks.
If the SPY were to make a big move the dynamics change. Let’s say SPY moved up $5.00 to $130. The maximum that was earned on the weekly option is the full premium of $1.47. The monthly would have earned almost $1.76 of the $4.40 (approx. result of delta, gamma and theta). So, straight up, the monthly option gains a slight bit more.
But, the big problem facing the weekly option is the second week. In order to earn the same $1.47 as the first week, the option strike must, once again, be set at-the-money, now $130. This works fine if SPY stays flat or goes up.
What if SPY makes a sizable move back down? If SPY fell back $5 to $125, the loss the second week would be $3.53 ($5.00 minus $1.47). This wipes out the whole $1.47 from the first week and leaves a net loss of $2.06 for the first two weeks.
The monthly, on the other hand, would have given back only the delta and gamma gains and kept the theta (time decay) of about 30 cents.
Now, assuming that SPY stays at $125 for the remaining three weeks, the weekly option would earn $4.41 more ($1.47 times three) and close at a net gain of only $2.35 (gain $1.47 week one, lose $3.53 week two, gain $4.41 weeks three through five). The monthly option, on the other hand, gained $4.40. But if the remaining three weeks showed more “see-saw” action before closing at $125, the weekly option could easily show a total net loss.
Of course, if a move back down was anticipated, a put below-the-money could be sold. But the put would have to be sold no lower than around $128 just to keep pace with the monthly option premium.
A similar result would occur if SPY started out by dropping $5 to $120 and then went back up to $125.
So, on the surface, the weekly looks better but it is susceptible to large swings. In fact, a swing of more than twice the premium received starts this dilemma. Since the weekly option premium is 1.2% of the price, this can happen whenever the swing is greater than +/- 2.4%. Over long periods of time this can be expected to happen infrequently.
This is a nice segue into our discussion of the high beta stock. In this example I’ll use Amazon (NASDAQ:AMZN).
AMZN is currently trading at $216.48. The $215 weekly put option sells for $3.35. The $215 monthly (five weeks) sells for $10.40. Once again, which one should we sell?
Following the same math as SPY, five weeklies equal $16.75. This is about 61% greater than the monthly option. Close to, but a slightly worse ratio than the SPY.
But, the weekly option represents 1.56% of the strike price. So, all the same advantages/disadvantages that were detailed for SPY exists, only the concern is a move greater than +/- 3%.
AMZN can and certainly does move more than this on a fairly regular basis.
In judging the two underlying, SPY and AMZN, I ask myself which is more likely: A weekly move of over 2% in SPY or over 3% in AMZN? Since I conclude that a large move is more probable in AMZN, I would tend to use monthly option expiry for AMZN. But for SPY I lean toward weekly options.
So far, these examples are given in the abstract. That is, they are absent any specific objective. The objective can tip the balance toward either the weekly or monthly.
For example, let’s assume AMZN is due to release earnings in a few weeks. If you conclude that the price might remain relatively stable leading up to earnings, weekly options might fit better. That would enable a switch to monthly before earnings are announced, or a radical adjustment up or down the week before any announcement (depending on your outlook). Absent this type of factor, I would go with the monthly.
Whether to use weekly options or monthly options on SPY also depends upon the objective. Today the weekly option is 1.2% of the strike. Maybe targeting an extrinsic return of 1.2% per week is too much and doesn’t match the objective. For instance, if you are selling the puts as a leg in a calendar spread you would want to earn potentially intrinsic and extrinsic value. The objective is for maximum gain on an up move, since you have a protective put in place, covering any potential downside. In that case you would want to be in-the-money and look for, say, just 50 cents per week extrinsic to cover a far dated option.
By example, a weekly option could be sold at a strike of $128 for a premium of $2.95. This represents 43 cents extrinsic and $2.52 intrinsic. A monthly could be set at $130 for a premium of $6.85. This represents2.33 extrinsic (approx. five times weekly) and $4.52 intrinsic.
Without going into all the “Greeks," SPY would have to move to over $130 in the first week for the monthly option to outperform the weekly option. Though a move this extreme is possible (just look at the last month) it is not likely on a continuous basis. Even if such a move took place, the next and subsequent weekly options could be reset at a lower strike (even at-the-money or out-of-the-money) in anticipation of mean reversion.
I have found a relatively easy method of analyzing the weekly versus the monthly option that should be available to any reader with even the most modest option calculating software.
To compare the weekly $125 put to the monthly $125, utilize the calendar spread strategy in your software. Enter the weekly option as a buy (I know you’re really selling, but enter it as a buy). Then enter the monthly option as a sell.
If your software allows you to adjust the premiums that are paid/received then make an adjustment to the weekly option that, in this comparison, is bought. Adjust the premium paid so that it is the premium that would have been received if sold. If your software doesn’t permit this you will be modestly off.
Then look at the result for the date the weekly option expires. This will give you the comparison of the two expiration dates and the result will show the advantage of the MONTHLY over the WEEKLY. Remember, this is not the result of one option, rather a RELATIVE COMPARISON of the two options.
Here’s the example for TEN $125 “at-the-money” puts, using Nov. 11 and December 17:
Price Points | P/L |
75.00 | $2,340.33 |
90.00 | $2,340.27 |
105.00 | $2,291.01 |
120.00 | $503.52 |
121.52 | $0.00 |
125.10 | -$1,432.56 |
128.36 | $0.00 |
135.00 | $1,809.25 |
In this case the weekly has a maximum advantage of $1,432 at a close on November 11 at $125.10. The “breakeven” is at $121.52 and $128.36, which then favors the monthly.
Here’s the example of the “in-the-money” $128 weekly put versus the $130 monthly:
Price Points | P/L |
75.00 | $1,311.74 |
105.00 | $1,309.18 |
120.00 | $798.31 |
124.30 | $0.00 |
127.87 | -$1,159.32 |
130.21 | $0.00 |
135.00 | $1,929.21 |
Once again, the weekly favors the upside to $130 to the detriment of the downside at only $124.30.
But remember, going in-the-money is specifically designed to capture upside at the expense of downside.
In conclusion, there is no “always win” of weekly versus monthly expiration dates. Outsized swings favor longer dates. Though not detailed in this article, decreases in volatility favor the weekly option while increases in volatility favor the monthly.
Foremost to consider, though, is the objective to be realized. Also consider if there are any particular circumstances that might favor one or the other. Consider weekly options for lower beta stocks such as SPY and monthly options for higher beta stocks such as AMZN.
Additional disclosure: I buy and sell options on SPY and AMZN.