Choosing An Expiration Date: Five Reasons You Should Sell Monthly Option Contracts

Weekly contracts, ones expiring on the Friday of every week, may be fun and keep you on your toes, but often times the risk is not worth the reward.  Entering a contract for 30+ days may seem boring, but there are many pros to taking the longer approach. In this article, I am going to review the benefits of not only selling monthly contracts, which are contracts that usually expire on the third Friday of every month, but I will also explain why it may be a good idea to choose an expiration date between 30 and 60 days. 

**Note– This article is writen in the perspective of selling options, not buying. 

1. Liquidity

One of the main reasons it is a good idea to trade in the monthly cycles is because this is where all the volume is. While I am one to believe that going against the grain is usually a good thing, with options you are going to want to follow the crowd. If you enter into a contract with not enough volume, you risk the possibility of not being able to exit the contract. Overall, monthly contracts have more volume and open interest than weekly contracts meaning that they are more liquid, or easier to cash out. 

2. Good Prices

As an option seller, you are looking for more expensive contracts and the further out in time you go the pricier they get. 

3. Extrinsic Value

To review, the extrinsic value of a contract is the extra monetary value given to the option which is associated with time and implied volatility. For the sake of this article, we will just focus on the time component of that so it is okay if you do not yet understand how implied volatility works in the setting of option contracts. Obviously, a contract with more time under it will have more extrinsic value. 

Moving on however, more time is not always a good thing, so where is that sweet spot? Tastytrade, a learning platform for options trading, reveals this to be around 45 days. But why? Option sellers benefit from the option prices decreasing and as time gets closer to expiration, options will lose their extrinsic value. Around 45 days, is when you will start to see that extrinsic value decay more closely. Meaning, your contract will be getting more and more value every day from extrinsic value decreasing (because of less time). However, if you have too much time on your contract, you will not see this added value due to extrinsic value decay until much later. Meaning, you would be taking on more risk, but without having the added benefit. This all sounds a little confusing, so to summarize the main points-

1. More time= more extrinsic value
2. More extrinsic value= more expensive contract
3. More expensive contract= good for sellers- You want to sell high and buy the contract back for a lower price
4. Every day that passes the contract gets cheeper and cheeper due to extrinsic value decreasing around 45 days 

4. Management

Another good thing about having more time is that you are able to manage your positions if they go south. 

5. Risk/ Reward

When entering a weekly contract, you are making a very risky trade with the hopes of making less money. Monthly contracts, specifically those within 30-60 days, 45 being the sweet spot, are quite the opposite. You are taking on less risk because you have more time to manage if things go wrong AND you are entering the contract at a better price. SO you have less risk, and more reward if you are in a monthly contract as opposed to a weekly. 

Summary

Overall, I am not saying that trading weekly’s is all bad. A lot of people are able to make these strategies work for them, and I find myself having a weekly option contract in my portfolio sometimes. The important thing to realize here is that there are a lot of risk eliminated when you choose to sell monthly contracts with a higher expiration date. Summarizing the main points of this article:

1. Monthly options are more liquid- you can enter and cash out more easily
2. Longer duration= more expensive contracts- better prices
3.  Longer duration= more extrinsic value, and extrinsic value decay is good for option sellers
4. Longer duration= more time to manage your position if things do not go your way
5. Longer duration= Lesser risk for a higher reward