Thursday, October 29, 2009

The Calendar Effect and Time Decay

Since the beginning of last year, I have periodically discussed what I call “calendar reversion,” which is essentially a phenomenon caused by the fact that the VIX is priced according to the calendar, but only calculated during trading days. The long and the short of this chronological mismatch is that market makers tend to drop option prices (and implied volatility) on Fridays in anticipation of the coming weekend and raise them on Mondays.

Earlier today, Mark Sebastian of Option911 wrote the best article I have seen on this subject, How Option Time Premium Decays Over the Weekend, in which he detailed his experiences related to weekend time decay and how market makers account for this during the Friday trading day. If you want to understand options pricing dynamics and how to best synchronize a five day clock with a seven day clock, then Mark’s work is absolutely required reading.

Note that Mark’s blog is one of the 15 entries in my new (as of today) Favorite Options Blogs list in the right hand column of VIX and More. In the past couple of months I have found myself going out of my way to assemble a Friday links post in large part to highlight some of the interesting work coming out of several relatively new options blogs. Now that it is no longer just Daily Options Report and VIX and More talking about options, I will do the best I can to incorporate as much of the excellent new information and analysis that can be found in all corners of the blogosphere.

For more on calendar reversion, readers are encouraged to check out:

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