Five-Week Expiration Cycles – Beneficial to the Investor or Not?
December-dated options expired last week, so this week begins the January cycle of expiration. Most cycles last four weeks -- but, since there are two full weeks left in December, and expiration occurs on the third Friday of each month, that makes this a five-week cycle.
But first, let us further examine what an options cycle means.
Options Expiration Cycles Explained
Option cycles are used for equity, commodities, and currency options.
It is a pattern of months in which option contracts usually expire (usually a nine month period).
Options Expiry Dates
All “options” have a limited useful lifespan and every option contract is defined by an expiration month. The option expiration date is the date on which an options contract becomes invalid and the right to exercise it no longer exists.
For all stock options listed in the United States, the expiration date falls on the third Friday of the expiration month (except when that Friday is also a holiday, in which case it will be brought forward by one day to Thursday).
There are three common cycles:
JAJO - January, April, July, and October
MJSD - March, June, September, and December
FMAN - February, May, August, and November
This week, let's take a look at some past data to see what these longer five-week expiration cycles mean for the market.
Four- and Five-Week Cycles
Below is a table summarizing S&P 500 Index (SPX) returns over four-week and five-week expiration cycles since 2009. Looking at the average and median returns, we can see four-week cycles have outperformed five-week expiration cycles. The last two columns reveal the main reason why. The longer-term cycles saw positive weeks outnumber negative weeks by two to one, but the weeks that were negative were huge losses. Three of the four losses in those five-week cycles were over 8%. Also, the positive weeks averaged a significantly smaller return than positive four-week cycles.
Weekly Results of Options Cycles
The table below breaks down the returns for those longer cycles, week-by-week, to help explain why the results are worse during five-week expiration cycles. Moving through the cycle, we see the first week has typically been positive, and the second week is frequently negative. The third week looks like a make-or-break week for the cycle. It has the best average return of the cycle (0.47%), but the last column shows the average negative return is a relatively whopping 4% loss. For some reason, that third week is quite volatile; it also has the highest average positive return.
The fourth week is pretty much breakeven, with a 50-50 split between positive and negative returns. It's that additional fifth and final week where things really go bad. The last week has averaged a loss of 1.16%, and has been positive only 33% of the time. Obviously four-week cycles are more beneficial to the investor.