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Using Weekly Options: A Play in Amazon


Using weekly options to reduce the cost of a longer-term position is a great way to manage risk and increase the probability of profitability.

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The introduction of weekly options some two years ago was met with both cheers and jeers. For active option traders the prospect of being able to tweak positions down to smaller time frames was seen as a positive. For skeptics who view most new products or innovation as a further corruption of the "invest for the long term" mentality, it is just one more way to for people to lose money in the increasingly casino-like atmosphere of financial markets. The truth, of course, lies somewhere in the middle and is mostly defined by how the products are used.

For starters if you don't fully understand it, don't use it. Even though I consider myself a fairly sophisticated options trader with a good grasp of both the conceptual and actual ramifications of changes in implied volatility, I don't trade the VIX (^VIX) products. They are not necessarily flawed, but for me there are too many moving parts -- such as options on futures of a statistical measurement with funky expiration settlements -- to feel comfortable. Leveraged and inverse products have daily rebalancing, which leads to a structural decline in share price over time. Some people love them just for that reason as they use pairs to create arbitrage advantages. But for me it just seems to complicate the issue so I stay away.

But options on equities or ETFs that have no different characteristics or specifications than the ones I've traded half my life, except that they get listed with a theta that has a half life of twice their monthly companions, is something I can deal with. Okay, I make that sound complicated. Weekly options are no different than "regular" options which can be listed with as much as two years until expiration (LEAPs) or one approximately 30 days until expiration and typically expire on the third Friday of each month.

That's enough preamble. Let's get to how I've been using weekly options.

Keep Time on Your Side

Many people view weekly options as a vehicle to make speculative bets in which they buy what seems to be "cheap" puts or calls in hopes of getting a high-percentage return with limited downside. While the options might have a low notional or dollar value due to their short life span they often are not inexpensive in terms of implied volatility for the very reason that people tend to bid them up for lottery plays or buy short term protection. For this reason I typically find weekly options to be a much better sale than purchase.

In addition to the relative expensiveness of these short-term options, they also come with the incredible tailwind, assuming one is selling, of accelerated time decay. Remember, theta is defined on a slope which starts to curve downward with about 15 days until expiration and then nose-dives in the final week. So I like to use weekly options to create calendar spreads in which I sell the short-term option as a way to reduce the affective purchase price of a longer-term position. One caveat being if there is known pending news, such as earnings or a regulatory ruling in which case the implied volatility -- which is really just an artificial expansion of time -- remains high and keeps premiums pumped up and needs to addressed on a case by case basis.

Take 33% Off on Amazon Spread

Last Thursday when Google (GOOG) was trading around $624 and had its next round of weekly options listed, I established a bullish position through the purchase of a January $625/$650 call spread along with the sale of the December 23 $635/$645 call spread for a net debit of $9.50. With the shares now trading around $630 the position is worth around $10, a minimal gain but one I expect to increase as those weekly options dive down toward zero in the next four days. On Thursday a new set of weekly options will be listed and I'll have the choice of selling another round of call spreads to further reduce the cost of the long January spread.

On Monday I did something similar in Amazon (AMZN). With shares hovering around the $180, I sold some weekly calls to help finance the cost of the purchase of a January call spread. It remains near these prices.
  • I bought the January $185/$190 call spread for a $2.00 net debit
  • I sold the weekly $190 calls for $0.50 a contract
This means the total cost for the three-strike position is a $1.50 net debit. This is $0.50 or 33% below the cost of just buying the January call spread. And come Thursday, I'll have a chance to roll my short calls into another round of weeklies, hopefully at a higher strike.

My thesis is based on both fundamental and technical considerations. Amazon has again made it clear that it will spend in the short term to build for the long the term. That has proved to be a winning formula but it creates knee-jerk selling pressure. The debate over Kindle Fire is overdone and creating near-term selling pressure. Amazon is selling a million of these devices a week. The numbers won't be revealed until after the New Year, which will keep the pressure on share price -- meaning it feels somewhat safe to sell calls that are some 5% out-of-the-money over the next two weeks. As far as the technicals go, the chart had a huge intraday spike down last week but still managed to close above the $180 level. It has now held that support for the past four trading days and sets up an attractive entry point.

Using weekly options to reduce the cost of a longer-term position is a great way to manage risk and increase the probability of profitability.

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No positions in stocks mentioned.

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