Top 4 facts which investors should know about trading in early half of expiry

Fact 1: The Theta decay in options is slow

If you are considering trading an instrument by buying an option and thinking of reducing the cost by selling some other strike option to get theta adjustment, that might not be a great strategy if you stand at the early part of the expiry.

The theta decay of an instrument is at its bare minimum and there is hardly any theta benefit from strategies like Bull Call Spread, Ratio Call Spread, etc.

Hence, the trading direction in early expiry may be more lucrative with plain vanilla option strategies like Long Call and Long Put.

For traders, trading oscillation in a range expectation may not get enough benefit from options sold and the options value will decay slowly.

This keeps the risk high, as there is very little to gain whereas from a long time to expiry the risk of underlying breaching the range stands high.

Fact 2: Low sensitivity to the Underlying

Options instrument are certainly derived from the underlying but early half of the expiry has a low sensitivity to the underlying instrument. Even post an adverse movement in the underlying a good portion of the option premium will still remain.

The reason for this is a high time value component in the option pricing which overrides some of the other pricing ingredients like a delta.

Fact 3: Vega is high due to higher increased uncertainty

The value of Vega (quoted as 1% change in volatility) is high in the early half of expiry as the time is long enough for a large impact on the underlying and that gives very low visibility of where the instrument shall expire.

Any change in overall market uncertainty could create a high impact on P&L due to Vega changes i.e. positive for Option Buyers and negative for Option Sellers.

Hence, writing options may again be less lucrative in early half due to high sensitivity to volatility and less theta decay to earn.

Fact 4: Gamma (Rate of Change of Delta) is High for ITM & OTM options

As the probability remains high for an option to move ‘In the Money’ and ‘Out of the Money’ during the course of its expiry due to any significant underlying movement, the Gamma value of options at the early half is higher in ITM & OTM options.

A significant move in favour will amplify the returns whereas an adverse move will have a meaningful impact.

Summary: Writing options in the early half of expiry is naturally lower on probability scale whereas trading options as a buyer for directional breakouts may be more lucrative if forecasts are available.

Disclaimer: The author is CEO & Head of Research at Quantsapp Private Limited. The views and investment tips expressed by investment expert on moneycontrol.com are his own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.