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Options Soar But Sometimes They Burn. Market Volume Update.

burning burning down chain reaction fire

Markets recovered on Wednesday after the “I” word (that’s inflation in case you haven’t heard) reared it’s ugly head once again to start off the week. Overall volume was down 5%, however, advancing volume reached the 3-DOG NIGHT level, a high we haven’t seen since the last accumulation day back at the end of March. Since then, distribution days have been piling up, but sentiment appears to be shifting as investors look ahead to first quarter earnings.

We sold our long term SPY 427 calls for a 0% gain (which is also a 0% loss, by the way), even though SPY was still more than 10 points higher than the at-the-money strike we got them at when we entered the position back on March 9th. How is it possible that SPY gained 2.5%, yet our options only managed to break even? Well, you can chalk it up to something called “theta burn.” Without getting too technical, or “Greek” as it’s known in the options world, theta is the effect that time has on your options premium.

Options rapidly lose their value as they approach their expiration date, which is why we always close our options at least a month before they expire. This usually keeps us safe from theta burn or time decay, but theta is also affected by how far out of the money the strike becomes. So basically, as time goes on, the underlying asset needs to keep increasing just so you can keep yourself above break even.

In the case of TVO, we expect that SPY will gain much more than 10 points in our time frame of 3 to 5 weeks, as determined by back testing and our actual historical trade record. In most cases, the exit triggers while SPY still has more room to run, so this week’s scratch was quite a rare occurrence. What’s also important to note is the oscillator has now gone below zero once again and may trigger another long signal in the next week or so, indicating that perhaps the real big swing move up is only just starting to develop. – MD

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