Choosing the Proper Expiration Cycle

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If you pick the wrong expiration cycle when putting on an options trade, it can ruin an otherwise successful position. That's one of the ways that options are so different from any other sort of asset: decide that you want to be long or short a stock and your work is almost done -- but deciding to be long or short via options leaves you with the important step of choosing the most fitting expiration cycle.

How do you choose? The first step is to let your thesis be your guide. If you like some stock or ETF because of a change in the fundamental outlook, or because you think the asset represents under-appreciated value, those sorts of theses will often take more time to play out, so longer-dated options are more appropriate. If you rely on day-to-day technical indicators or short-term estimates of volatility, you can trade shorter-term options as well.

In a recent position for OP, we looked at improving economic data for South Korea and entered into a bullish vertical put spread to profit from the expected stability and/or improvement in the iShares MSCI South Korea Index Fund ETF (EWY). One reader raised the excellent question of why we chose an expiration date for the position that was almost two months away.

With only 16 days left in the nearest expiration cycle, there wasn't enough time to let the thesis of the position play out. Additionally, with so little time to expiration, any market noise or other exogenous factors could affect the position and leave us with no time to wait for a recovery. In options lingo, we say that there is too much short gamma near expiration, meaning that the effects of price swings in the underlying asset have an ever-larger impact on the profitability of the position as expiration gets closer. Some traders love to trade options near expiration, and there are smart ways to do that, but this position wasn't one of those.

What about longer-term options? The reason we didn't look many months into the future for this particular trade is that, when you enter an options position, you are in some sense "married" to the strike prices of the options you choose. We didn't want to be quite so committed to a particular set of strikes at an 80-day horizon; instead, we reserved the right to trade the in-between June cycle and then, if our core thesis was confirmed, enter a similar position for the July cycle at a later time with strike prices updated to reflect any movement in the underlying ETF.

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At the time of publication, Jared Woodard held positions in EWY.