Monday, October 20, 2008

Option expiration week

The following statistics offer mean S&P Index returns and associated skew values for each trading day within the 3rd week of the month (AKA Option Expiration Week), for the decade starting from 1998. 1 While you should not anchor on these figures entirely, they do provide a pretty good picture of how the stock markets move for the week.

Data source: Advanced Option Pricing Models

Mean Return

This gives the return of highest frequency for the studied period. Most would conclude that this points to expiration week Tuesdays as favorable buying days, and vice versa on Friday. I would highly advice against that sort of presumption. Historical price movements have little if any affect toward that of the future.

Expiration week Friday however, is another story. This is what often happens…

At the last hour of trading of Thursday, many option traders sell Out-of-the-Money Index Put Options, expecting them to expire worthless within a day, thereby keeping the premiums, and of course dismissing the risk of a dramatic volatility jump. The big players buy these OTM Puts, being on the other side of the trades. Then Friday comes and the big guys pump the markets full of selling orders, forcing these options into money as the index drops, and they invariably end the day with up to 5,000% profit from the options (while the sellers lose their shirts, remember Niederhoffer?)

Neat trick huh!


These numbers, in my personal opinion, offers more value than the former. It comes in the form of standard deviations. OK, we all know normal distributions do not apply to financial markets, still this figure provides one of the most vivid imagery of the fat tails. The highly negative values suggest that even while the markets had moved upwards more often, when it drops, it drops like there’s no tomorrow.

I suppose that added to another reason why I usually prefer short selling than taking upside bets. Anyway, while these numbers do not provide a “holy grail” sort of thing, they do offer a bit more reality of how markets actually perform.

0 Reflections: