The Weekend Effect

Knowing the theta decay and other market measures look at every day of the week including weekends, an opportunistic trader might conclude that the ideal theta to collect would be when nothing trades. Unfortunately everyone else knows that there is a weekend ahead and adjusts formulas accordingly.

The most common method used in dealing with this for option pricing is to decay theta for Friday, Saturday, and Sunday throughout the day on Friday. This could mean that the first 2 hours of the session trims that Friday’s theta from contracts, the next 2 hours trims Saturday’s theta, and the final third of the day handle the theta that would decay on Sunday. This accelerated decay schedule is adjusted to deal with market holidays and other deviations to the regular 5 day trading week.

So ok, there’s no juice in a Friday at close to Monday at open trade, but look what we just did to a Friday at open to Friday at close trade! Yes that means that Friday’s theta decay should be 3 times any other day. Of course that wouldn’t apply to a contract expiring THAT Friday, but for a contract expiring the following Friday, you can experience 3 of the remaining 8 days of decay in a single session.

You can also try to exploit this through a Calendar spread, pitting one percent of theta decay against another. An example of this would be selling a SPY option that expires Monday and buy the other that expires in a week. Your short option will lose 75% of its theta days as opposed to only 37.5% of theta days for your long strike. But understand that you’ll still have gamma risk for that one day hold, in that a large move in spot will impact you long dated leg more than it can impact your short dated leg.

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