One of the smarter and more successful traders I ever came across is a huge proponent of short premium when trading options. He’s got a natural gift when it comes to numbers, and for him the probabilities associated with short premium (and theta decay) simply can't be ignored.
I can recall the few times he left the office on Friday with a net long (paying) theta position in his overall portfolio. On those rare occasions, you might think he was getting his wisdom teeth pulled over the weekend, or attending some extremely unpleasant event - it was that painful for him.
This particular trader loved the "free weekend theta" concept, as he viewed Saturday and Sunday (when the options market is closed) as "free money" in terms of theta collection. While he is technically correct, that theta decay does occur "daily” (including Saturday and Sunday), there is one important risk factor that often gets overlooked in that line of thinking.
If youre looking to better understand the concept of "weekend theta," then a new episode of Market Measures should be right up your alley. On the show, the hosts explore new tastytrade research on this precise subject.
As a reminder, theta is the Greek that measures the rate of decline in the value of an option due to the passage of time. All else being equal, options systematically lose value as time passes in the lead-up to expiration. Theta reports how much value an option should theoretically lose in value on any given day.
This brings us back to the concept of "free weekend theta." Because "Saturday" and "Sunday" exist (despite the fact that options markets are closed) traders who are short premium are collecting theta on those days, and long premium traders are paying.
The big question, however, is whether that should be thought of as “free money.”
In order to help answer this question, the Market Measures team designed and executed a study to produce a side-by-side comparison of pertinent historical data.
In order to isolate results that would help provide illumination on this topic, the Market Measures team looked back in history and backtested the average P/L of a one-day hold for a simple short premium position (short strangle).
The most important distinction in the study is that selling on Friday is different than any other day of the week, because you need to wait through Saturday/Sunday before closing the position on Monday. One-day positions executed on any other day of the week can be closed the very next day.
Given the above, it probably won’t surprise you that the average P/L of selling on Friday, as compared to any other day in the week, did produce the greatest return. The graphic below highlights this finding clearly:
What we see in the above is that “weekend theta” does exist. The superior results when selling on Friday, as compared to any other day of the week, cannot be denied.
However, one critical piece of data not covered in the above graphic is risk. One can’t forget that selling on Friday opens the position up to greater risk, because of the potential for a gap move on Monday (after two full days in between) is theoretically heightened.
On the second half of Market Measures, the hosts walk viewers through the method by which they establish that the risks of selling premium on Friday are greater than any other day in the week.
We hope you’ll take the time to review the complete episode of Market Measures focusing on weekend theta when your schedule allows.
If you have any questions about theta, or want to share your own experience, don’t hesitate to leave a message in the space below, or reach out directly @tastytrade (Twitter) or email@example.com (email).
We look forward to hearing from you!
Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.
Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.