Trading Options at Expiration: Strategies and Models for Winning the Endgame
Jeff Augent
Core Points:-
Short straddles later on expiration day, when pinning is evident (such as it moved to 1 new strike and back to the old strike)
Long straddles during midday IV stability window (after 1030am)
Ratio trades are best to hedge against both sides 1:3, long/short OTM calls
Can also do evening before expiration days.
- reduced risk/return profile
- limited market exposure
- extremely high returns on a percentage basis
- directional neutral strategy
Long positions designed to profit from underlying price changes are best structured after IV stabilises early in the day
Conversely , traders who structure early short positions often find that midday price changes can be costly, especially if IV temporarily rises.
Simple short positions designed to benefit from IV collapse perform best late in the day, after stock stabilises near a strike price and most large positions have been unwound.
Long $530 calls, and short $540 calls ratio 1:3
pinning behavior due to delta hedging large numbers of long positions.
stock prices hover around strike prices as large institutional investors unwind complex positions ahead of expiration.
Pinning - (page 41) rarely mentioned result of pinning is tendency of some stocks to exhibit unusually large price changes on Monday following expiration.
Tendency can be exploited by purchasing long straddles just a few minutes before expiration on stocks that close expiration Friday pinned to a strike price.
Statistically speaking, these straddles generate disproportionately large returns because they are mispriced.
Market adjust to the overnight time decay in the day next morning.
Conservative may create short positions in morning and close them at end of trading session. (pg44) This is best on the Friday preceding expiration week, compensation price change of 19%. However market response is not 100% efficient. The full amount of intersession loss is often not realised unless the trade is left on until the next open.
Stock $123
10 Long $120 calls
30 Short $125 calls
If stock consistent, generate 95% profit.
If stock climb $2, still profit (52%) due to long trades. Furthermore if stock pinning effect holds and stock pins to $125, positions can be held till expiration ($125 calls expire worthless)
Downside- stock decline rapidly the next day. Unlikely, even if stock open down 10%, the long side can still retain half its values, and can close with just a small loss. Risk/Return very favourable.
The bigger risk is stocks rallied beyond the upper strike price, and way beyond the long hedge.
a) simplest is to purchase long straddles on stocks with a history of large expiration day price changes
executed at point of symmetry when stock crosses a strike price during midday flat IV window.
Open Interest and Option volume at various strikes can indicate price movement
b) AAPL, GOOG, GS, MA, RIMM
These (a) stocks and (b) stocks are 73% and 125% mor e likely than expected to close expiration within $0.20 of a strike price.
Comparing the number of minutes that contains a strike price cross to the number of minutes where each stock traded more than $1 from a strike (The final column lists the number of expirations within $0.30 of a strike)
________________________________________________________________________
Ticker Minutes >$1 from strike Strike Crosses Ratio Expirations <$0.30 from Strike
________________________________________________________________________
AAPL 2847 147 19.37 2
GOOG 2740 498 5.50 4
GS 2845 285 9.98 2
MA 3100 306 10.13 1
RIMM 1952 223 8.75 3
Hence Short Straddles on GOOG, and Long straddles on AAPL
GOOG has high IV after earnings, good for short positions. Ratio trades as well as short straddles, with GOOG having pinning effects.
In most cases, holding these trades beyond 14:00 will reduce or eliminate all profits.
More than 50% profit is commonly
Ratio trade 1:2 or 1:3 depends. Best to take advantage of time decay that is heavily on Thurs.
Another option is long call/short call both OTM
Stock-$164, long $165/ short $170 (1:3)
Best to close on Friday evening and restructure new trades meant for Expiration Day Trading.
Long straddle and long strangle don't work due to efficiency of market and large stock movement needed.
1 long vs 3 short (1:3 ratios not fix, adjust based on as delta neutral as possible)
As both sides can generate significant profit, it is not meaningful to think of it either as a long position hedged against downward spikes, or short positions hedge with long options. Both are correct.
If it goes in long directions, the long positions appreciate in value.
Cost of trade is minimal, as short positions pay for the long positions.
-most profitable when stocks in constant motion (page 134)
- move from 1 strike price to another strike price
Timing very important as initiating a long trade at the open or very late in the day can be dangerous because both are commonly characterised by rapidly falling implied volatility. In additional, when a stock trades near a strike price, the closing hour is often distorted by unusually small price changes
- A short position is an excellent choice whenever a stock climbs from 1 strike to another late on expiration Friday, crosses the new strike, then falls back and stabilises (page 137)
short straddle late in the day after the stock had gravitated to strike price, and IV was collapsing.
Strike price effects drove the jump from from $210 to $220 (long straddle) then it sticks to $220 (short straddle)
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