Expiration Week – Equity Options Set to Expire
by Ian Harvey
April 16, 2012
Introduction
At the end of this week, equity options are set to expire. The table below shows that expiration week has tended to be a bit bearish over the last couple of years -- averaging a slight loss, with 52% of those weeks being positive. One misconception about expiration-week is that it is always highly volatile. It is assumed that traders exiting option trades and rolling new positions -- along with the hedging of new positions, or taking off hedges -- naturally leads to big market fluctuations. However, measuring volatility by standard deviation of returns, you see expiration-weeks are actually less volatile than other weeks. Perhaps the potential for volatility is there, but over the last couple of years, it has not actually been realized.
“Standard Deviation” is.....
1. A measure of the dispersion of a set of data from its mean. The more spread apart the data, the higher the deviation. Standard deviation is calculated as the square root of variance.2. In finance, standard deviation is applied to the annual rate of return of an investment to measure the investment's volatility. Standard deviation is also known as historical volatility and is used by investors as a gauge for the amount of expected volatility.StdDev(r) = [1/n * (ri - rave)2]½
where the terms ri are actual values of the investment's annual rate of return, taken over several years, n is the number of values of ri used, and rave is the average value of the ri.
Therefore, standard deviation is a statistical measurement that sheds light on historical volatility.
For example, a volatile stock will have a high standard deviation while the deviation of a stable blue chip stock will be lower. A large dispersion tells us how much the return on the fund is deviating from the expected normal returns.
Each Day of Expiration Week and the Results
Below is a chart showing how each day has fared during expiration-week. One thing that stands out is that, despite a high percentage of days being positive, the week itself averages a negative return (see table above). For example, 67% of Thursdays during expiration-week have been positive, but the average return on Thursday is actually a loss of 0.11%. It is obvious that there were some pretty dramatic down days on Thursdays. Friday also averages a loss, although 70% of those days have been positive.
This next table shows the last five expiration-weeks by day, along with the return for the week. Note that in each of the last four expiration-weeks, both Thursday and Friday are positive.
The Week Ahead
The last couple of weeks have been tough for the market. The S&P 500 Index (SPX) has lost about 2% so far during the April expiration cycle. There has not been a negative cycle heading into expiration since August 2011. Looking back to 2010 again, the table below shows this is not a good omen for expiration week. When the cycle is negative heading into those last five days, expiration week has typically extended the losses, with the SPX dropping, on average, another 1.5%. The index managed a positive finish only two out of six times in those situations. If the cycle is positive, then expiration week averages a gain, and is positive over half the time.
Below are the six instances when the SPX was sitting on a loss for the expiration cycle heading into its final week.
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