Weekends and option pricing

[Fox]

Hi guys,

I have a question about the effect of public holidays and weekends on option pricing. I have read a few blogs where the authors state that market makers factor in the weekend and public holidays by lowering the IV. This makes sense to me intuitively, because the option writer will be taking less risk if there are less trading days, and should therefore be compensated less ie. by being paid a lower IV.

1. Can anyone confirm that this is indeed how MM's handle holidays and weekends?
2. If so, when do the MM's tweak the IVs down? If today was Friday and the MM's were to tweak IV to factor in the weekend ahead, would they lower IVs at start of trading, midday, or end of day?

Thanks.

 

[wayneL]

Hi guys,

I have a question about the effect of public holidays and weekends on option pricing. I have read a few blogs where the authors state that market makers factor in the weekend and public holidays by lowering the IV. This makes sense to me intuitively, because the option writer will be taking less risk if there are less trading days, and should therefore be compensated less ie. by being paid a lower IV.

1. Can anyone confirm that this is indeed how MM's handle holidays and weekends?
2. If so, when do the MM's tweak the IVs down? If today was Friday and the MM's were to tweak IV to factor in the weekend ahead, would they lower IVs at start of trading, midday, or end of day?

Thanks.

Hi Fox,

1/ Yes

2/ IME it varies a little bit. Sometimes they're done as early as Thursday lunchtime, but most certainly all factored in by Friday lunchtime. Also IME it's never done at the start of a trading session, but often you see the IVs dropping away pretty soon after the open.

 

[Fox]

Thanks Wayne. Very interesting. I felt the impact of this IV drop for a fly I just opened late this week. I was not sure if the IV fell due to actual vol of the underlying or due to the "weekend effect".

I wonder if is possible to make a quick profit on a short vega position (eg. IC) by opening your position late in the week (say Thurs) and closing it off on Friday. In other words, you get 4 days of time decay, while risking only one day of exposure. Food for thought.

 

[Grinder]

Can work Fox. When IV has been elevated a few days before a long weekend, been able to take off on the Friday. Always a nice surprise when it happens, just don't catch it all that often.

 

[cutz]

Hi Fox,

Thanks for raising the topic, I was scratching my head last night when the euro market was being pounded but IV change showing red, I can't really recall if the same thing happened on the oz market, probably wasn't paying too much attention, something to look out for next week.

Sounds like a good day for selling backspreads.

 

[Fox]

I can't really recall if the same thing happened on the oz market, probably wasn't paying too much attention, something to look out for next week.

I had an XJO calender initiated about 3 weeks ago which barely survived the recent price adjustment, if not for some drastic kung-fu moves. Early yesterday morning, I was almost able to exit with a decent profit. However, as the day progressed, the calender deflated like a balloon with a slow leak. Eventually, the chance to exit with a decent profit just fizzled away.

Oh the other hand, my iron fly was gaining at an unexpectedly fast rate. Only a couple of days old and I could already exit with a small profit.

Start of rant .....

I'm starting to get disillusioned with calenders. They are great when wild downward swings occur because the IV kick really eases any pain. But watching your profits fizzle away with falling IV can be quite painful to watch. Most painful is watching your P & L graph at expiry sink below zero when IV goes against you. At least

... end of rant.

 

[Grinder]

I'm starting to get disillusioned with calenders. They are great when wild downward swings occur because the IV kick really eases any pain. But watching your profits fizzle away with falling IV can be quite painful to watch. Most painful is watching your P & L graph at expiry sink below zero when IV goes against you. At least

... end of rant.

Your not the only one. Have also had limmited success with calanders and DDs of late, many things have to go right, especially ones view of vol. Only using them as a small part of my overall portfolio these days.

 

[sails]

Agree with the comments on long calendars - they are a waste of time and money in a falling IV environment. Conversely, OTM put calendars can be good if one expects the market to fall with the usual increase in IV - but needs to be weighed up against simply purchasing cheap OTM puts. Even one long put can make more money on a down move than a larger size calendar spread and often with about the same risk and also removes some contest cost.

I have found doing reverse diagonals to capture an up move can work quite well - often producing a lower risk trade with the advantage of falling IV helping the further out OTM short call. Because the short has to be bought back when the long expires (or alternatively take on the higher risk of leaving it there!) it rarely fully reduces the cost of the long call. The short can then be managed by rolling up and out (usually at very little cost, if any) if the market continues on it's merry way up. Also, care needs to be taken with the front month long call to ensure it doesn't get hit with too much time decay - it can often be rolled as well - either horiziontally or diagonally if one wants to stay in the trade.

Just some food for thought - hope it makes sense...
We have moved, but not properly settled yet so no live trading at this stage. Too many interruptions with little people have slowed the process down considerably...

PS: Also agree with IV dropping by Friday afternoon especially - can be a good time for buying!