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Month-End Options Can Present Opportunity


Consider the calendar when it presents an opportunity to sell call options in between two expirations with a wide date gap.

Today is expiration for month-end options. These options are most often found for a quarter end – as in this case, this is the end of the traditional first calendar quarter of 2012.

While I typically use the traditional options expirations (options expiring on the third Friday of the month), sometimes the calendar lines up just right for a chance to use the month-end expirations. This month was one of those months.

If you noticed, the third Friday in March was two full weeks ago. And the April expiration is still three weeks from today. This is one of those months that has five full weeks between the normal options expiration dates. But it also had a month-end option in between.

This periodic calendar anomaly is interesting for the investor who sells monthly calls on his positions as part of a collar hedge (or it is just interesting if you just like to sell covered calls).

At the normal options expiration in March, you found yourself looking to sell a series of calls against your positions – and you saw five full weeks until the next expiration. Typically, the next expiration is only four weeks away – though the five-week expiration does occur a few times a year depending on the calendar.

When selling calls, the five-week window can look daunting. You are trying to pick the upside strike price that the stock will ideally finish just underneath at expiration. But five weeks is an extra week of risk where the price could appreciate past your strike – and therefore you might be more likely to sell away the upside. Of course, you are compensated for that extra week in the price of the option – but the compensation is usually not linear. In other words, the compensation for the extra week is rarely 25% more than the price the option will trade at one week later assuming no movement in the market price of the underlying.

So, what we typically do at my firm is wait that first week and look to execute when the expiration is closer to 28 days away – versus 35 days. That way, we have an extra week of price discovery before we set our call strike price. However, this month, the calendar gave us a small opportunity to sell the calls that were expiring only 14 days after the prior expiration. In other words, we sold the 14-day options immediately after the last expiration.

The two weeks of time value we sold was obviously a smaller amount compared to the 28-day or 35-day amounts. However, it provided an extra chance to sell a near-expiration call. We know that time value evaporates fastest in the final month, weeks, and days of any option. The rate of evaporation keeps accelerating all the way up to expiration. So, this was an extra chance to sell an option expiration.

With only two weeks to go, we had to sell call options with strike prices that were lower than we would typically sell if we were looking a full four weeks out. We also had to accept less overall time value – but on a time value per day basis, we were still compensated well.

Now that these options are all mostly expiring out of the money today, we will look to sell options again – this time the ones that expire three weeks from today. It was effectively a chance to "double-dip" in selling options in a five-week window.

Not all options offer the month-end expiration dates – but many of the largest ones offer them, including SPDR S&P 500 (SPY), iShare Russell 2000 Index (IWM), and PowerShares QQQ (QQQ). And usually you only see these month-end expirations at quarter end. In the end, consider the calendar when it presents this opportunity to sell call options in between two expirations with such a wide date gap.

Editor's Note: For more from Wayne Ferbert, go to Buy & Hedge ETF Strategies.
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No positions in stocks mentioned.
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