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Weekend Theta

Options trading involves the concept of "weekend theta," which influences the value of options during weekends. Weekend theta refers to the additional time decay experienced by options when the market is closed for two days. Time decay, also known as theta, quantifies how an option's value decreases as time passes. Even though options cannot be traded during weekends, their time value continues to decline as they approach expiration.


Option sellers can benefit from the weekend theta effect as the additional time decay allows option sellers to collect more premium, assuming other factors remain constant. 


Both traders and dealers are aware of this effect and in order to prevent risk-free opportunities, dealers deploy anti-arbitrage techniques, such as allowing implied volatility (IV) to decrease towards the end of a Friday. However, traders can still strategically capitalize on the weekend theta effect. A possible approach is to construct spreads that span the weekend. 


For example, if a position is opened on Wednesday and closed on the following Wednesday, any disruptions or market fluctuations that might have discouraged arbitrage efforts on Monday would likely have diminished. This enables traders to capitalize on the extra time decay over the weekend and potentially benefit from the competitive edge offered by the weekend theta effect.


Writing options over a weekend, particularly during extended weekends, creates the risk of random and potentially severe tail events due to the increased time available for extreme market movements. This is precisely the risk that long option holders are counting on. 


To mitigate the risk of significant directional moves, it is preferable to implement this strategy in a positive market gamma environment, where both implied and realized volatility are lower. In contrast, during a negative gamma regime, the market experiences higher relative volatility, making it more susceptible to violent swings and large opening gaps.


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