Weekly options have become a stalwart among options traders. Unfortunately, but predictable, most traders use them for pure speculation.
But that’s okay.
As most of you know, I mostly deal with high-probability options selling strategies. So, the benefit of having a new and growing market of speculators is that we have the ability to take the other side of their trade. I like to use the casino analogy. The speculators (buyers of options) are the gamblers and we (sellers of options) are the casino. And as well all know, over the long-term, the casino always wins.
Why? …because probabilities are overwhelmingly on our side.
So far, my statistical approach to weekly options has worked well. I introduced a new portfolio (we currently have 4) for Options Advantage subscribers in late February and so far the return on capital has been slightly over 25%.
I’m sure some of you may be asking, what are weekly options. Well, in 2005, the Chicago Board Options Exchange introduced “weeklys” to the public. But as you can see from the chart above, it wasn’t until 2009 that the volume of the burgeoning product took off. Now “weeklys” have become one the most popular trading products the market has to offer.
So how do I use weekly options?
I start out by defining my basket of stocks. Fortunately, the search doesn’t take too long considering weeklys are limited to the more highly-liquid products like SPY, QQQ, DIA and the like.
My preference is to use the S&P 500 ETF, SPY. It’s a highly-liquid product and I’m completely comfortable with the risk/return SPY offers. More importantly, I’m not exposed to volatility caused by unforeseen news events that can be detrimental to an individual stocks’ price and in turn, my options position.
Once I’ve decided on my underlying , in my case SPY, I start to take the same steps I use when selling monthly options.
I monitor on a daily basis the overbought/oversold reading of SPY using a simple indicator known as RSI. And I use it over various timeframes (2), (3) and (5). This gives me a more accurate picture as to just how overbought or oversold SPY is during the short-term.
Simply stated, RSI measures how overbought or oversold a stock or ETF is on a daily basis. A reading above 80 means the asset is overbought, below 20 means the asset is oversold.
Again, I watch RSI on a daily basis and patiently wait for SPY to move into an extreme overbought/oversold state.
Once an extreme reading hits I make a trade.
It must be pointed out that just because the options I use are called Weeklys, doesn’t mean I trade them on a weekly basis. Just like my other high-probability strategies I will only make trades that make sense. As always, I allow trades to come to me and not force a trade just for the sake of making a trade. I know this may sound obvious, but other services offer trades because they promise a specific number of trades on a weekly or monthly basis. This doesn’t make sense, nor is it a sustainable and more importantly, profitable approach.
Okay, so let’s say SPY pushes into an overbought state like the ETF did on the 2nd of April.
Once, we see a confirmation that an extreme reading has occurred we want to fade the current short-term trend because history tells us when a short-term extreme hits a short-term reprieve is right around the corner.
In our case, we would use a bear call spread. A bear call spread works best when the market moves lower, but also works in a flat to slightly higher market.
And this is where the casino analogy really comes into play.
Remember, most of the traders using weeklys are speculators aiming for the fences. They want to take a small investment and make exponential returns.
Take a look at the options chain below.
I want to focus on the percentages in the far left column.
Knowing that SPY is currently trading for roughly $182 I can sell options with a probability of success in excess of 85% and bring in a return of 6.9%. If I lower my probability of success I can bring in even more premium, thereby increasing my return. It truly depends on how much risk you are willing to take. I prefer 80% or above.
Take the Apr14 187 strike. It has a probability of success (Prob.OTM) of 85.97%. Those are incredible odds when you consider the speculator (the gambler) has less than a 15% chance of success. It’s a simple concept that for some reason, not many investors are aware of.
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