The Risky Allure of Weekly Credit Spreads

Anyone who has any experience with trading options welcomed the advent of weekly options as they provided two great benefits; flexibility in trading and a way to greatly benefit from the acceleration of time decay as expiration approaches. It’s wonderful to that tailwind of a positive theta.

The popularity of weekly options also grew just as interests rates were heading towards zero in the wake of the financial crisis. Which made the allure of generating steady income for yield starved investors, especially those heading towards retirement, very attractive.

Suddenly there was proliferation a newsletters promising you all kinds of ridiculous returns like “5% per week”. What they don’t tell you are the risks that come with those returns. I would like to share a letter from one of those “gurus” from last year that was posted on Steady Options.

“Short term weekly options trading remains a tough road in 2016 as the weekly market volatility is whipping around weekly option traders. Case in point, our newsletter experienced a losing trade last week as bulls hammered markets higher. The loss was unfortunate but what really stood out to us were the reactions and sheer surprise of some traders.

Below is a copy of what we sent to our members over the weekend to remind them of just how aggressive (and volatile) weekly options trading can be:

Last week’s loss stings, of course. The market ground higher all day Friday eating further into the expiring call spread. What was worse was that prudent adjustments for the trade were nonexistent.

Our weekly credit spreads are highly exposed to Gamma (the option greek) and the latest trade was a textbook example of it. As SPY ground higher debits to adjust exceeded $0.10 to simply the move the trade out a week and up $0.50. Doing so would have resulted in the new adjusted trade still being well in the money. We have been bitten before by that bug (paying to adjust higher while not actually reducing the risk to the new adjusted trade) before in March 2016 and did not want to repeat that experience.

The issue with weekly credit spreads is that everybody likes the fast pace weekly profits of weekly credit spreads until they take a loss. The weekly credit spread game is that there are many, many small profits and the losses are ALWAYS larger than the gains. That is how it works. That is risk curve of weekly credit spreads.

Although, when a loss occurs, retail traders become flabbergasted. The biggest misstep most retail traders make is underestimating the aggressiveness of our newsletter (and weekly credit spreads in general) due to its years of fairly smooth profits.

Retail traders are lulled into a false sense of security with weekly credit spreads forgetting that along with extreme profits (>4% per week and >100% per year) comes a healthy dose of risk. Look at it from another view: If large profits like that were easily available at low risk wouldn’t everybody be producing them? Mutual funds and the like?

Weekly credit spreads are very volatile and aggressive; despite how their ease and consistency can lull you into a sense of safety. Think about, you don’t make >4% PER WEEK by not taking risk.

The real success and consistency over the long term in selling options is using expirations further out.”

The emailed response provides a good dose of honesty and reality. Unfortunately, most don’t get the message until large unexpected losses are incurred.

So here a few suggestions I’d like to make:

  • Make sure you understand the maximum risk that can be incurred for each trade and size the positions accordingly.
  • Don’t stick to just weekly options; use longer dated ones too which will allow for wider spreads and going further out of the money. Long dated are also easier to manage in that profits can be taken sooner and losses minimized.
  • Combine both bullish and bearish positions.
  • You don’t always have to have open positions. If attractive trades based on technical or risk/reward due to low implied volatility don’t present themselves it’s better to sit out a week or. Why risk a potential 150% loss to earn 3%?

Weekly options are a great tool. Just be aware of the risks that come with the allure.

— Steve Smith