Time Decay and Holiday Trading

In today’s option trading blog I will discuss why Exchange Holidays need to be factored into your trading plan. If you were considering a trade a few weeks ago, the Memorial Day weekend should have been taken into account. There is a pattern ( it’s more pronounced from April – Sept.) that encompasses extended weekends. The prior week will include a day or two where most of the activity takes place. As the weekend draws near, the volume subsides. If you’re a premium buyer, know that a thief will be at work. If you’re a seller, know that the risk level may be elevated. Let’s look at the next major holiday – Independence Day. July 4th falls on a Tuesday this year. That means that Monday will be a non-event since most traders will make it a 4-day weekend. Here’s how the last week of June is likely to shape up. Monday, Tuesday or Wednesday will contain one or two nice trading days with good movement and activity. Thursday afternoon, holiday fever will begin spreading. Traders will be more focused on their Friday Tee-times than the market. Those who show up Friday will work the first few hours. If all is quiet, they’ll get a jump on the traffic and leave early. Experience has taught them that there is little money to be made. In fact, the action can be whippy and unpredictable. Why waste a nice day and run the risk of losing money? On the backside, there’s a good chance Wednesday (July 5th) will be quiet as well. Traders will be trying to get their bearings and some will still be on vacation. Including this “holiday hangover”, premium buyers have been stripped of a week’s worth of “action” This year’s Memorial Day weekend was atypical. There was a good move Friday and a nice move today (Tuesday). Normally the pre-holiday activity is more subdued with a tighter range. I attribute the movement to the sharp 5% pullback that started a few weeks ago. The market is currently in a state of flux, hence the larger than normal moves. This price action does illustrate another point. Exaggerated moves can take place during light volume days because there are less traders to stand in the way. The net affect of both days (Friday and Tuesday) is marginal. Be aware of any economic news that may be released during the pre/post holiday trading sessions as you form your plan. They may also have an elevated affect on the market. Am I telling you to sell premium during this period? No, often some of the “juice” has already been taken out in anticipation of the calm. Chances are you won’t be selling “rich” premiums the week before. With lighter trading activity, a small news event or a large order can drive the stock. Your risk might actually increase without the corresponding reward. Am I telling you to buy premium? No, realize that premium decay and the passage of time will be working against you. The lesson is to be cognisant of the event and to account for it in your plan. If you were planning to buy July options now, you may want to buy the next month out (Aug) knowing that your trade may need more time to “work”. If you are short options, you might want to plan on buying some in just before the holiday if the premiums have already dropped. If you are initiating a trade at the end of June, your plan might reduce the size of the position. I have found that price movements in active markets with “full participation” have substance and are much more reliable. My job as a trader is to predict and my performance increases when the conditions are right. Consequently, I tend to reduce my exposure going into holidays. I can fully enjoy my time off and when I return, this approach helps me resume with a clear perspective.