Don’t Trade Before Option Expiration

Today I closed my long position on UCO.  If you recall, this was a complete accident but I ended up benefiting from it since UCO gained pretty significantly in the last two days.  I still have my POT (put option) which will probably expire worthless even though POT price is lower than when I bought it.  This is solely because of time decay and option expiration.

For those of you who doesn’t know much about options…options expire every third Friday of the month. So for this March, it means in two days.  Now option price is made up of two components: time and intrinsic value.  And the closer you get to the expiration date (3/20/09), the more worthless your option price becomes if your “strike” price is not within a profitable range.

Today I bought a put position (short) of SKF, getting ready to turn bear slowly since I’m banking that this bull rally won’t continue forever.  SKF is also near the previous support levels  of ~$100.  Now I made the biggest mistake of buying SKF option that expires in 2 days instead of in April.  That was again…a complete accident..driven by my stupidity trying to buy something right before market close…driven by my urgent work related issues.

In the last 15 mins of market day, my option value went down from $1500 to $950!! (-30%)

So here’s a lesson for the day:

Here are the reasons why:

The closer you are to the expiration day, the more price swings.

– Since your “time” component of option price becomes worthless and worthless as you approach the expiration date, your option price swings become more and more volatile based on the movement of your underlying stock price.  Therefore, for something volatile like SKF that can go down in value by 10% in an hour…it’s a killer.

– Option prices in general are more volatile in nature near the expiration date

No room for error

– Because your option price nearing expiration is mainly dependent on your underlying stock’s price, if you are wrong about the direction in which the stock price will go (bull for calloption, bear for put option), you got a few days to pray before your option expires that Friday!  On the other hand, if I had bought an option that expires in April, I could have held it longer with a higher chance that the stock price will hit my “target”

Cramer said so

“Options expiration strikes again. Just when it looked incredibly ugly and I was prepared to hit a million bids to take away the pain, I remembered my options expiration rule: Walk away from the table, lest you do something stupid as wood to your portfolio.
Just as professional drinkers stay at home on New Year’s Eve, professional traders like to stay out of the office on expiration. You simply don’t want to cause lasting damage based on the phony nature of what occurs on expiration day.
That’s why I think the best way to play these days is to go out to lunch. Which means I take lunch 12 times a year. See you at the Grill Room third Friday in March.”

I am praying today that SKF will go above $120 so I don’t lose $1500 out of pure stupidity.  I blame my stupid work for this.

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