Weekly options: A business approach

March 16, 2015 12:00 PM

Dan Sheridan has seen the options business from both the institutional and retail sides. After 24 years as a Chicago Board Options Exchange market-maker and another 10 years as a options mentor for private traders, his approach has remained consistent: To be successful, you must treat options as a business.

“This is a craft,” he says. “We practice it daily. For those with the consistency and discipline, it becomes a good business.”

More recently, the practice has had a weekly focus. Weeklies have been the growth end of the options business. More contracts have come on board, and more volume is being traded. There are compelling reasons why:

Less capital: “You can achieve higher yields with less capital. If someone is seeking to make $500 per week, or $2,000 per month, with weekly iron condors, it takes $10,000 capital earning 5% per week. If someone wanted to achieve the same $2,000 per month via monthly iron condors with a duration of 30 days from expiration, it would take capital of $40,000 getting 5% per month. That’s four times more capital,” Sheridan explains.

Less risk: He also points out that some weekly strategies call for the trade to be on only two or three days. The trader is then out of the market two or three days and faces no exposure. Contrast this with a classic monthly option trader who is taking on 30 to 40 days of market risk. 

Options decay: Sheridan is an option seller. He does this in different ways. For example, his favored vehicles include calendar spreads, butterflies and double diagonals--no naked options. He makes money by the decay in the options he sells. These strategies all have one thing in common: They work from faster decay in short options relative to long options.

Statistical probability: If you are selling out-of-the money (OTM) options that consistently carry a 70%, 80% or 90% statistical probability to expire out of the money—and are not exposed to naked risk—over time, you’ll win. Sheridan does this using iron condors. 

Consistency: To make statistical probability work, though, you’ve got to be there, week in and week out. Sheridan is in the market every week, not just for the occasional speculation that may or may not work. He knows if he takes a loss this week, most likely he’ll see a profit the next, and the next, and in the long term, his winners will overtake his losers because the statistical probabilities are in his favor.

“If we can have a year-end weekly iron condor record of 40 wins and 12 losses, and keep losses to a level not much higher than the wins, you will be successful,” he says. 

Management: Finally, he has predetermined contingency plans for market moves, both up and down. In a word, he adjusts the trade to stay near “delta neutral,” meaning that if the underlying moves $1, the value of the options position changes little or nothing. Ideally, at a particular point in time, the beginning of the trade, you are not leaning long or short. Once the market moves up or down 
$1, the “gamma” (acceleration of change in the delta) makes you long or short. 

There are myriad ways to do this, including rolling up or down, adding options, subtracting options, etc. But the goal usually is to put the position back to neutral. This allows for the inevitable zigzags of the market, such as market regression, and maximizes time in the trade, which in turn, allows the magic of theta (options decay) to accrue. The concept of adjustments also includes the concept of maximum loss: exiting the trade when a pre-determined loss level is hit.

“If I’m putting on 50 weekly calendars a year, I’m not going to let one wipe out three or four weeks of profit,” he says.

Sheridan also teaches “no touch” versions of most strategies, where you simply exit a position when a profit target or loss target is reached, no adjustments.

“This is more of a couch potato approach,” he says. It is popular among some of his students for its simplicity.

Sounds simple enough, but the real world application can be a bit more daunting. For example, while profits can accrue more quickly in weeklies, so can losses. One’s “technique” and strategy must be in place before the trade is put on. Here’s a close look at one of his favored vehicles.

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About the Author

John Sarkett is the author of several books on options, including “Option Wizards: Real Life Success Stories from the Financial Markets.” His e-mail is jas@option-wizard.com. Dan Sheridan can be reached at dan@sheridanmentoring.com.