Trading Volatility Skews

Put Time On Your Side

Many conservative income generation trading strategies depend on the time decay inherent in options pricing. When I establish an iron condor well OTM (out of the money), I am selling option spreads and expecting those spreads to slowly lose value as the underlying stock or index trades within a channel. Other traders may use butterfly spreads or place OTM credit spreads on one side only (calls or puts); all of these trades are based on time decay working in the trader’s favor. This is in contrast to the long option position designed to benefit from my prediction of a particular directional move for the underlying index or stock. Those positions lose value over time if the predicted move does not occur, so time is not your friend for those trades.

One of the items on your checklist before making a trade should be a glance at the calendar to see if any exchange holidays are upcoming. When time decay is on your side, exchange holidays are also your friend. If the market isn’t open, it can’t move against your positions, but time decay is still occurring and improving the profitability of your position. I will often establish my OTM credit spread positions before long holiday weekends to add to my edge.

Another important factor to keep in mind is the historical seasonality of volatility. Trading activity slows during several of the holidays every year, as traders take time off to be with their families and exchange business tends to slow. March and October have historically displayed the highest volatility for the year, whereas the summer months and the week between Christmas and New Year’s Day are historically slow periods of market activity.

An old wall street maxim is “sell in May and go away.” It refers to the tendencies for many market participants to take vacations and long weekends over the summer, resulting in lower trading volumes and lower volatility. This tends to favor strategies like iron condors that benefit from slower moving, sideways markets.

Another factor tracked by many traders is which monthly options cycles have 5 weeks and which only have 4 weeks. Option prices will be skewed because of the number of days in an option cycle.  If your trading style involves consistently selling premium each option cycle, you should be aware of the five week option months, since the amount of premium income may be affected.

Options trading strategies that benefit from the time decay of options prices are attractive for monthly income generation. Pay attention to the calendar and put time on your side.

About the Author

Kerry W. Given, Ph.D., aka Dr. Duke, has over twenty years of experience investing in the stock market and over seven years experience trading equity and index options. He has taken many classes on investing and trading through the years and has discovered first hand how difficult it can be to separate the financial facts from the marketing hype, myths, and get rich quick schemes. He can be reached at:

www.ParkwoodCapitalLLC.com

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