Time Decay Trades

Time Decay

I noticed last week that SPY had an extra expiration tomorrow, 31 March 2009. It has an extra quarterly expiration. June 30th will be the second quarter expiration, 30 September is the third quarter expiration and 31 December is the fourth quarter expiration.

So last Friday I sold some 83 SPY calls since the weekend is half the remaining time on the options. That way, the options lose half their remaining time value while hopefully nothing happens. Of course, over the last few months of the Bush Administration there was a new initiative to save the financial system announced every Sunday night.

I thought that the last day to trade it is today. That’s because I was confusing trading the ETF which is what SPY is with trading the index itself.

Monte Carlo Calculation

This morning, I calculated, using a Monte Carlo calculator from Option Strategist, that there was a 30% chance that SPY would wander out of the breakeven range of 81.2 to 76.8.

Monte Carlo programs were invented by Stanislaw Ulam, one of the creators of the Hydrogen Bomb at Los Alamos. He named it after the most famous European casino. The way it works is it cuts up time into little steps and then randomly picks a price change from a distribution of price changes. It adds up all these small price changes through time. After the program has traveled the whole time span it sees where it ends up. Is it past the breakeven points? Then that is one path that is outside the limits. Then the program creates another path and sees if that path ends up inside the limits or outside. It does this ten thousand or one hundred thousand times and then totals up all the times that it ended up outside the limits given and returns that number.

The breakeven points are equivalent to 812 to 768 on the S&P 500. The market opened 2.5% down. As of 2PM, the high for the day so far 79.87 and the low is 78.45. I sold the 79 strike straddles so the high is within one percent of the straddle and the low is also within one percent of the straddle. It looks like the market will stay in the range.

Today’s Close

The close for the S&P 500 today is 787.53 so the ETF closed at 78.75 since it trades at one tenth of the S&P 500. I sold the straddles for an average price of 2.16 and bought them back at the end of the day for 1.90 so I made 12%. I realized my mistake when at 3 PM the straddles still held most of their original value.

It will be interesting to see if this trade works tomorrow, the real expiration day.