Pros and Cons of Selling Weekly Options (Part 3 of 3)

Does the frequency with which you get paid (in the form of a job) limit the amount of money you earn?

In his book The Top 10 Distinctions Between Millionaires and the Middle Class, Keith Cameron Smith believed so.

He noted that those on the lower end of the socio-economic spectrum tended to get paid more frequently - as in weekly or bi-weekly.

Case in point - those at the very bottom, such as day laborers and the homeless, struggle on a regular basis to scrounge together enough money just to get through another day.

The wealthy have a different mindset - and a longer view of things.

Their payouts are much greater, but the timeline for their larger business ventures and investments to really pay off often requires a much longer runway.

So is that also true when it comes to option trading?

Throughout this series, we've been looking at durations and expiration dates when it comes to buying and selling options:

>> PART 1 - Best Durations When Buying and Selling Options

In this article we looked at how theta - or the dynamic rate of an option's daily time decay - impacts long and short options alike.

I made the case that, all else being equal, you're much better off buying longer dated options and selling shorter dated options.

(Check out the above article if you're not sure why.)

>> PART 2 - The "Sweet Spot" Expiration Date When Selling Options

In this follow up article, we looked specifically at selling or writing options.

We discussed the "sweet spot" that balances higher annualized returns on a trade (the shorter the duration, the higher the rate) with total initial downside protection (the farther out in time you sell an option, the greater your protection).

For me personally, I find the optimum balance between annualized ROI and initial protection to be somewhere in the 3 week to 45 day range.

So Why Do So Many Option Traders Sell Weekly Options?

In Part 2 of this series, I mentioned that I know many traders insist on selling weeklies (even inside the Leveraged Investing Club).

And that's fine.

I'm certainly not interested in a knock-down-drag-out fight debating about who's right and who's wrong.

I'm all about everyone making their own informed choices based on having clarity about the working components of a process.

So I thought the best way to wrap up this series is to drill down a little more and take an unbiased look at the pros and cons of selling weekly options.

Advantages of Selling Weekly Options

Clearly, the number one advantage of selling weekly options vs. monthly options is that you're going to collect premium at a much higher annualized rate.

I love the annualized metric because it easily allows you to compare different scenarios, situations, and trades.

I liken it as a speedometer for your returns - it basically tells you how fast your money is making more of itself.

And it's pretty straightforward.

Would you rather earn 15% annualized selling an option that expires in one month?

Or 25% annualized selling a comparable option that expires in one week?

In this example, selling the monthly will bring in more total premium.

But if you're able to successfully and consistently sell those weeklies at the higher rate, then over the same one month period, both your annualized and total returns would nearly be double that of the monthly option seller.

Another advantage is that, theoretically, you won't have any open positions over the weekend.

That's a personal preference, of course.

But some traders absolutely hate leaving a position open over a weekend and being exposed to unanticipated negative news events while the market itself is closed for two days.

There may be exceptions, of course, such as an ongoing position that needs to be managed or repaired, but in theory at least, selling weeklies gives you a much better shot at clearing the slate at the end of each week.

Disadvantages of Selling Weekly Options

As we've already noted, the biggest disadvantage is that selling weekly options provides a lot less initial downside protection than does selling monthly options.

Obviously, the farther out expiration is, the more premium you're going to collect when selling an option at a certain strike price.

With a naked put, for example, your initial downside protection is the strike price (times 100 shares for each contract you're selling or writing) less total premium collected converted back into a per share calculation.

The benefit of more upfront premium goes beyond downside protection.

Yes, the weekly rates when selling options are much, much better than those of the monthlies.

But it's unrealistic to assume that a stock is just going to sit there trading flat for a month while you continue rolling or re-selling your near or at the money short puts every week in order to maximize those shorter duration rates.

Pragmatically then, if you are selling weekly options instead of monthly options, you're probably going to be trading a lot of different stocks rather than the same one or same ones repeatedly.

There's nothing inherently bad or wrong about that, of course, but part of your success will be dependent upon how effective you are in finding attractive new short option trade setups each week.

If you have an effective process for finding quality trades already rockin' and rollin', then it's a non-issue.

But if you don't, or if you struggle to consistently find great trade ideas, it's a factor you really need to consider.

Don't forget commissions!

Another potential disadvantage that we haven't discussed yet is that commissions are going to eat up a higher portion of your total returns.

And that can take a significant bite out of your otherwise higher higher annualized returns.

Well, yes and no.

Commissions will be a larger factor when trading fewer contracts, or if you're using a broker with higher commissions (duh!).

Conversely, they'll be less of a factor when selling a larger number of contracts per trade, or if you're using an online broker with super cheap commissions (e.g. Interactive Brokers or TastyWorks).

Again, you'll have to evaluate whether this is a factor for you based on your own circumstances.

Your weekends are free, but your days are not!

Something else with implications that might not be obvious at first glance.

If you primarily sell weekly options vs. monthlies, you're going to end up managing and monitoring a LOT more positions over time.

Selling options - even short duration ones - will never be as high maintenance or stressful as day trading (at least it shouldn't be).

But the math is still very simple - if you trade weeklies, you're going to have 4-5 times as many trades to deal with as someone who only sells monthly options.

Summary - The Right Balance for You

Whether you sell monthly options (like I tend to do) or weeklies, we can all agree on these mathematical facts:

• Shorter durations equal higher annualized rates
• Longer durations equals more total premium collected up front

I've spelled out what the right balance is for me, and why.

But at the end of the day, only you can determine what the right balance is for you.

You Might Also Like . . .

Best Expiration Date for Covered Calls - While the principles we discussed in this series also applies to covered call expirations, there may be situations where an investor chooses a longer duration when writing covered calls.

Naked Puts vs Covered Calls - Is There Really a Difference? - It may not be obvious or intuitive, but selling cash secured puts and writing covered calls are very similar, and can often be considered identical trades, especially if your objective is near term, high yield income. This article demonstrates how and why.

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