Shubham Agarwal
India is a country of festivals. Our diversity makes the calendar filled with festivities. Festivities means trading holidays. We all know Options are sensitive to time. Any extra day of no trading hours other than Saturday, Sunday impact the Option premium.
Let us look at the impact that this extra time off has on Options premium and then figure out 3 modifications that will help us cope with this impact effectively.
Time based decrement in Option Premium also known as Time Decay or Theta Decay is more impactful than usual when we have more than usual time off. Especially the trading holidays on Monday and Friday that makes 3 days straight holiday or Long Weekends impact the most.
Here we need to safeguard from 2 Problems that we will run into.
#1 Reduction in Premium that hurts Option Buyer
#2 Often the market exhibits bigger gaps when it resumes after a longer than usual holidays.
For these problems following 2 modifications would help reduce impact.
#1 Gap Safeguard with No Net Sell in Options.
All of us get tempted to Sell options when we know that the time value related reduction in premium will be heavy due to no movement in stock or index due to trading holiday. However, remember the rest of the world as well as the factors impacting the stock market do not take a holiday. Big drop of 2008 happened on a Monday.
So, the easiest way to deal with this is to avoid taking net sell option position carried forward though the long weekend. This does not mean we do not Sell Options.
Considering the amount of money will anyways be little more than usual due to big holiday, might as well spend some of that premium in buying Protection. This means that if we have sold a Call/Put Option we should think of Buying a relatively Higher Call/ Relatively Lower Put Option of the same expiry. This Option can be as far as 3-4 strikes away. This modification will help in 2 ways.
Firstly, the biggest loss that this trade can give in any case is defined. It is difference between the bought and sold strike minus the net Premium received. So, no matter what happens to the market we can have a safe night sleep.
The extra premium earned on the Sold option would help compensate for the loss made on the Option bought. However, second help is Sell + Buy Option position would reduce the margin requirement meaningfully. This will help maintain the Return on Investment.
#2 Timing Option Buy and Sell
Remember the drop in Option premium will not be straight forward. This means there will be slow and steady reduction of premium on Thursday/Friday in reaction to upcoming Long Weekend. So, it is always a good idea we time ourselves, if we are not too dependent on price action.
1. Do not wait till the last hour to Sell Option and try to create a sell position before noon of the Thursday/Friday before the long weekend.
2. Try to delay Option Buying towards the closing hours of the Thursday/Friday before the long weekend
These are some tactics that have worked for me. If does not help a lot, it would not hurt.
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