Finding the answer to the question above is not easy, but we’ll try in this article anyway.

Definition: Short-term options trading

First of all, it has to be clarified what is meant by”short term”. There are basically two different interpretations: On the one hand, short-term options, i.e. options with a short residual maturity, could be meant. On the other hand, it could just refer to the holding period of the traded options. Both variants have advantages and disadvantages, which we will discuss in more detail below.

Options with low residual maturity

If one uses options with a low residual maturity, one experiences the largest time value decay in percentage terms, which is very good for option sellers and very bad for option buyers. When trading with very short-term options, however, there is a very high risk of gamma sensitivity. This primarily affects option sellers. As we are primarily option sellers, in order to take full advantage of this trade, we want to minimize the risk of short options, especially during the last 7 trading days. Of course, there are also exceptions, such as covered options, where the risk is only in the underlying.

For options with low residual maturity, we can conclude by saying that you should rather do without as an option seller. Naked trading in these options is more of a gamble, both as an option seller and as an option buyer.

Short-term trades with options

Things are different when we talk about trading options with a relatively short holding period. By “short” we mean not just a few hours, like intraday trading, but a few days. The well-known advantage of the decline in the time value is not the focus of this trade, but the change in the implied volatility and the movement of the underlying in the desired direction.

Prime examples of a planned short holding period are news events, such as interest rate decisions, press conferences, presentations, important reports on commodities or quarterly numbers of companies. When trading these events, as an option seller with various strategies, you bet on a decline in implied volatility, which results in a falling option price. In this way, the option seller can buy back his options more cheaply and make a profit. Depending on the strategy, it does not matter in which direction the underlying moves.

The basis of this approach is that the implied volatility withdraws when the news becomes known. In other words, if uncertainty is high in the market, then implied volatility is high. If the uncertainty deviates, the implied volatility decreases.

The graph below shows the implied volatility of Facebook in:

It can be clearly seen that once a quarter, implied volatility increases and subsequently collapses again.

There are also other uses for trading options that you just want to keep short. Here are some examples:

  • Hedging for existing positions
  • Trading spreads with clearly defined risk
  • Purchase long-term options for a directional trade to save margin

Tradimo and short-term options trading

Tradimo only very rarely pursues very short-term options when trading in the real money account and tends to focus on relaxed trading, which requires little time. Our trades run on average 2 – 3 weeks. In doing so, we combine the benefits of option selling and benefit from both high time decay and high implied volatility.