It all stems from the fact that market makers are also very logical and are not in the business of giving away free Theta to the retail trader. In essence, the market makers begin to move their computer system clocks gradually forward from around the end of business on Thursday. This has the effect of pricing the Friday open by the close of business on Thursday, by midday on Thursday they are reflecting the close of markets on Friday and by close of business on Friday they are reflecting the opening of the markets on Monday morning.
Let's have a look at the numbers to prove the theory. Using and Iron Condor on the SPX as at Thursday July 2nd 2009, we have the following option chain prices:
(Click on the image to enlarge).
Lets now see how the pricing of the Iron Condor has changed by the open of the markets on the Monday morning, the 6th July 2009 :
On Monday we see that the price has moved down by $5.70 (A), Using the short 1000 call leg as an example, we note that the Delta has moved from 7 down to 4.4 and that the option price has moved from $2.35 down to $2.05, a price change of $0.30.
So we see that the short option has dropped -$0.30 over the weekend, but what was the cause of this move - was it Theta related?
Step 1 - Calculating the average Delta : Thursday Delta @ 7 + Monday Delta @ 4.4 / 2 = 5.7.
Step 2 - Calculating the price effect of the Delta move : Price change -$5.70 * Average Delta move 5.7 / 100 = $0.32.
Thus almost 100% of the change in the option value over the weekend was due to price effect and Delta and not Theta.
Cheers
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