In this episode of the SCT Podcast, listen to Shecantrade review your options for selecting the best expiry date for your options trades. Options traders have lots of choices when it comes to picking an expiration date for their trades. Many traders simply pick the date that looks best to them, but there are better ways. Listen to find out how to pick the optimal expiration for your long and short options trades.
Sarah: Hi, everybody, this is Sarah Potter. This is the SCT podcast. Happy to have you all here today. I have TJ with me.
TJ: Good afternoon.
Sarah: And this is episode 37. And today we’re going to talk about how you pick expiries. I mean, in options, we have the lovely ability to pick how long we want to be involved in a trade. And so often, this is a question that we get asked a lot is how you make a decision about what week to trade when you can basically trade any week in a stock or any other trading instrument in options. So, how do you make that choice. I think this is a good discussion because TJ and I sometimes have a different points of view on this is to how many weeks to really hold trades. So, I think the first thing you want to think about is how much money are you actually interested in risking because the further you go out, the longer the time you’re giving the trade, the more expensive generally it’s going to be to be involved in that trade. And so, there has to be a balance with how much money you’re willing to put up versus actually figuring out, you know, I think this time frame is actually going to be quite soon so I think the stock is going to move, let’s say in a couple of weeks, so I only want to have a couple of week expiry versus you know, I think it’s going to go up and I don’t really know when so I’m going to go out a month or two and hope that it goes up in that time. So, TJ, what do you think, when are sometimes, or how do you make choices about expiry?
TJ: Well, I guess first I have to, I want to look at the type of trade that I’m trading, whether it’s a spread or if it’s a directional buying long puts or long calls. I typically look for, I look first, I guess, let’s kind of talk about this maybe as a checklist. So, first, I look at the market. Is the market really trending? Is it moving sideways? Are we getting lots of different news? Political, economic. It’s just a lot coming out all the time. It’s maybe that causing the market to move back and forth. And then, I’ll look and I’ll say, okay, “These are the market conditions.” Is this a time that I want to spend a lot of time in the market with my trades? Or is it a time where things are happening so quickly that maybe I only want to be in the trade two or three days. And I don’t want to sit for weeks on ending a trade because we don’t know what’s going to happen if there’s going to be another government announcement or economic announcement. So that’s kind of the next step. And then I’ll tell her to, “Am I buying a put or call or am I selling a credit spread?” Generally, credit, I will only do week of so it’s a decision, “Do I get it on Monday, Tuesday? Or do I get it on Wednesday, Thursday for the Friday expiry?” But then for long puts and calls, I like to give the trade enough time to work but I also don’t want to get into a situation where the expiry is so far out on the put or call. That price is moving, may move over the next two or three days but the option doesn’t really respond because there’s so much time to expiry. So, I like to weigh those. So, I think for me, usually two or three days for credits, for spreads and I’m probably three weeks out for long puts and calls?
Sarah: Okay, but that three weeks out on a market that’s moving, would you suggest that once a market is sideways, are you still picking that same three-week window or are you adjusting if the market is consolidating?
TJ: I think the market is really slowly consolidating. I’m probably not trading the long puts and calls anyway, so it wouldn’t really be, it wouldn’t be something that I’d really look at.
Sarah: So, I will basically make my choice about what week to trade especially for directional trades for buying calls and puts. Also, based on volume and where there are other people. So, sometimes, I might want to give it three weeks or four weeks to place the trade, to have the time. And I generally like to have a few extra week, so if I think that a stock is going to move let’s say this week, I will not trade with this week’s expiry. And that’s just because your faded decay is going to be too influential in the same week of expiry. So, if the option is going to expire in the same week, even if I think the move is going to happen, because you’ve got so much time decay value coming out of that option because it’s an option that’s going to expire that week, generally, those trades won’t be as favorable as if you went out at least one more week. So, I kind of think about it like, “Okay, do I think the move is happening this week?” Then I want to give myself an extra week just in case I’m wrong. And then I want to give a week for time value so that generally, I’m not in trades in the last week of expiry. So, that’s kind of my rule of thumb, so, I would suggest that I would meet a three-week window is the first place I’m going to look. So, if I want to buy a call, I’m always going to start at three weeks out. But there are also times when three weeks out, there’s no volume so it doesn’t make sense with the trade that week either. And that’s what I’m going to go out further or go in a week and start to consider whether or not it’s worth taking those trades instead. So, I’ll stick with the same strike but I’m going to start looking at various weeks just to see if there’s a nice place where there’s other people that are already trading so, looking at open interest in volume and looking for other positions to already be there. I don’t want to be the only person trading at a strike. I find that that’s just, those trades don’t work out as well versus when I’m in trades where there’s other people as well. I mean, that’s a whole other podcast too we could do down the road. So, there will be times that I will go out. But yeah, I mean, we’re both very similar in terms of our style for calls and puts, but there are times do you ever take trades that are out further? Like going out more than three or four weeks?
TJ: Not typically an option, no. If I’m going to trade a moderately expensive stock and I’m buying an option that say three or four, six months out in the future and I want to buy that in the money with a high delta. I mean, at some point, the benefits of buying the option are kind of reduced ‘coz I might as well go buy the stock ‘coz that option is going to be a big chunk of the cost of the stock price if I’m going that far. And it expires so I’d rather spend, instead of spending 30 or 40 dollars on an option that expires, I’d rather spend maybe a hundred dollars share on a stock. At least I know that stock will still be around typically. I may be able to hold it out a little bit longer if something happens whereas the option it’s, you’re committing a lot of capital and it could just expire worthless.
Sarah: Yeah, and you know, from coaching a lot of people to, when we talk about trading options, sometimes, people get really focused on the expiry like what week should I pick for their trade to end. And I also suggest, a really good tip, is to think about the trade from the beginning. So, if you identify that you think a stock is going to move, let’s say this week, but you look at it, and let’s say in a shorter term time frame like a 60-minute chart, there’s a bit of resistance. So, what sometimes traders will say is, “Well, there’s resistance here so, I have to go out a week.” Where I would say, “There’s resistance here so, I’m not going to trade it this week.” And so, you and I, that person and myself, we might end up with the same expiry but I’m going to get into the trade a week later. So, I’m not going to pay for that risk to be in that first week while there still is resistance where somebody else would. Perhaps, their perspective, what I can hear sometimes is, well, it’s cheaper then so I’d rather get into that option where it’s cheaper when there’s still resistance. And I guess, from my point of view, yeah, it could be less but if there’s resistance there, the market hasn’t proven that it’s actually going to move in a direction you want yet, so it would be better to sit and wait to see how that moves first rather than going out and spending more on an extra week. Just because we have the flexibility of trading options with more weeks, it doesn’t always necessarily mean that that’s something you should do. And I think, when we’re trading, I mean that’s the downfall of options because you have so many choices. Sometimes, instead of making a good trading decision from the beginning people say, “Well, I have a choice so I’m just going to mitigate some of these by these other choices that I have and that’s why I’m going to place a trade.” I don’t know, have you ever encountered something like that?
TJ: Yeah, I think that’s I would agree, I think that’s pretty common. I’d also suggest to that if we think that the market is pretty accurate and fairly priced on the options chain, the market has a pretty good idea where price will go, and the options, if you look where the market thinks it’s going, those options will end up expiring worthless. It’s just the reason why a lot of times, straddles don’t work because the market is priced in that move and the market is generally right which is why we like to do spreads, credit spreads. We want to take the other side of that market. So, if we think that we want to trade high probability trades, we want to look at the options chain for evidence, I would tend to suggest that the market is more accurate the closer you are to now. The market expiry this week is probably pretty well-priced if I go out a year or eight months or nine months, that accuracy I think diminishes so there’s a lesser probability. So, I think if you go out and you want to rely on the probabilities from the options chain from the market, and you want to go out eight or nine months and you want to buy these long date options, I think the market isn’t as accurate out there. So, you’re relying on information, you’re paying for example, a premium maybe, for an option that the market isn’t really accurately priced. There may be a lot of discrepancy where prices are at that point which is where a lot of these longer term trades, they’re pretty binary. I mean, they either work or they don’t. And I think we also have to think too that if you do believe that in the distance that the options chain that it is fairly priced, then you have think about how is that options chain becoming fairly priced? Well, the market makers, the market in general, not just the market makers, each trader, the supply and demand is out there is there is going to be a lot of will room priced into those options, they are going to be expensive to cover that unpredictability. And, you can look at it and direct something that’s very easily noticeable implied volatility, that’s one input of market volatility. And if we look at that and we put all that together, then we really have to say why are we trying to outguess the market, if we think we can, that’s great, so say we do outguess the market, but we’ve potentially paid so much for that put or call, that by the time we get to where we need to go, we really haven’t made all that much profit because we’ve spent so much on it from the get go. And I hope that makes sense but what I’m trying to say is that it goes back to the whole no free launch. We think that’s there’s potential for a lot of profit eight or nine months and we see it but how many times does that really come, does that really play out? And I think we have to remember that that we need to look at that in the future as well.
Sarah: Yeah, I think that’s actually really good advice. Don’t get caught up in thinking that we can outsmart the market. You might as well work with the market because there’s a lot of trades to be had that are there right in front of you. So, I just want to thank everybody, we’ve had a lot of really great feedback lately on the podcast, everyone’s really liking this new format, and I do, too. I think somebody kind of summed it up as it sounds like the two of us are just kind of having a coffee and a chat about options and I don’t know, I think that’s a really nice way to think about it. We do appreciate your reviews, though. The reviews are very important especially in iTunes, so if you could take a couple of minutes and post an honest review of the podcast up there in iTunes, we’d really appreciate it. And of course, we’d always love to see you guys at shecantrade.com. Happy trading, everybody.
Thanks for listening to a Shecantrade Review of the Markets