“Time is money,” as the adage goes. That couldn’t be a truer statement when it comes to options trading.
Since options have an expiration date, most people associate time with options trading. And the time to expiration is arguably one of the most important components of options trading and investing.
After all, once an option expires, so do your chances of making money… or making more money.
The time that I am referring to is not decay or the expiration date. It’s the actual time of day that you should and shouldn’t trade options.
The worst time to trade options is between 9:30 (market open) and 9:50 a.m. ET*. If you want to get less for the options you are trying to sell, then trade between those times.
Between 9:30 and 9:50 in the morning, stocks trade at their most unpredictable levels of the day*. If you haven’t noticed this, then you should spend a couple of mornings studying it. Aside from some aberrations, the normal trading patterns go something like this… Stocks react to overnight news, earnings results, geopolitical news and market pundits in the hours and minutes leading up to the open.
Then stocks open with a ton of investors making bets driven by news and nothing else. This is impulse buying and selling.
Sure, you may want to exit a position after bad news or enter a position after good news, but everyone else is thinking the same way. It’s like a herd of elephants trying to squeeze through a French door. It’s not pretty.
The market makers – those in charge of setting the prices based on supply, demand and experience – are making the prices. If they see a ton of buying, the price will go up quickly – maybe even before the shares open. If they see a ton of selling, they will do the opposite and drop prices sharply.
That’s a look at the stock market from the inside. Now, imagine what the options market is like.
It’s a market where prices are derived from the underlying stock price but trade on leverage. (Think of options as stocks on steroids.) If a stock moves up a couple of percentage points at the market open, the option may move up 10%.
The options pricing model incorporates several factors: the expiration date, the volatility of the shares, the volatility of the market and a couple of other lesser inputs. If any of these inputs are magnified in either direction, the effects on an option price are magnified as well.
From 9:30 to 9:50 a.m., the pressure on the market makers to price options is huge, and they are not willing to take the risk until shares prices have settled down*. On a normal day, that takes about 20 minutes. On a volatile day, it could be an all-day affair.
The way you know this is to look at the spread at the open versus the spread later in the day. At the open, the difference between the bid and ask could be anywhere from 30% to several hundred percent. By midday, that spread could be a fraction of a percent.
Take it from someone who has traded options for more than 25 years… You owe it to yourself to be patient.
Don’t act on that recommendation to buy or sell an option at the open unless you just don’t have a choice.
Rare cases aside, you are better off skipping the first 20 minutes of stock and options market trading.
*According to Karim Rahemtulla’s proprietary research