I must have been trading options close to a year before I heard the term "amateur hour," referencing the first hour of trading. Oops. I'd been trading amateur hour all that time. And you know what? Sometimes I still do.
The first hour of trading has well earned that term. Two difficulties related to that time period sometimes trap traders into bad trades, bad executions or both. Here's why the first happens: early moves sometimes reverse. A lot of terms have been invented to describe this tendency, including pop-and-drop and gap-and . . . well, you can fill in the rest.
Annotated 15-Minute Chart of the Russell 2000:
Although the quick reversal on the price chart provides its own warning, channeling systems such as Keltner channels or Bollinger bands can help traders identify when an early move might be extreme and subject to a quick reversal. My current charting program does not support Donchian channels, but with my last charting service, I used them to identify extreme moves, too. Breakouts above or below Donchian channels in the first few or last few minutes of trading should always be considered a bit suspect. I set them for 20 periods and used an offset to identify moves more quickly.
When trading the OEX and SPX especially, I also chart the advance/decline line on Keltner charts and watch for similar setups when the early move might be too extreme. This can provide corroboration of what you're seeing on price charts. Sometimes the A/D line warns of a potential reversal before price changes dramatically, providing a warning to would-be traders to hold off entering that new trade that looks so enticing. Volatility measures can do the same thing.
Annotated 15-Minute Chart of the VIX:
As this evidence suggests, by whatever measure you use to determine when a move might be extreme, be a bit skeptical of any early morning move that violates those extreme levels. I prefer to use some sort of channel or band system. Maybe you'll use some calculation of standard deviations or something else that's your preference.
The first problem with amateur hour, then, is that early extreme moves are suspect. Another problem exists. During a February 7, 2008 "Options Safari" webinar on CBOE.com, Dan Sheridan discussed getting good executions on trades. He spoke about executions from the perspective of someone who traded in the pits for decades. Those in the pits will be studying their inventories first thing in the morning, he said. Don't bother them then.
Well, Sheridan didn't actually speak that last sentence, but he did list three possible time periods for getting the best executions, with the 8:30-9:30 am CT period definitely not being his favorite for good executions.
If you must trade during the first hour that the cash markets are open, Sheridan said, make it as late in that hour as possible. He advised that the first half hour of trading, market makers are dealing with their inventories and somewhat uncertain about the direction of the market. If you need to take action in the morning, maybe let the markets settle for a half hour first. If you're considering a spread order, the end-of-the-day period might be best. Market makers don't want to carry too much risk overnight, so although they might not have accepted a trade earlier, they might be willing to do it then. For example, perhaps they don't want to be long so many deltas, so they might sell a call that they wouldn't have sold earlier for that price, especially for mid-price.
That's Sheridan's take built on his experience in the thick of things in the markets. To us out in the retail trader world, what's happening with the people on the floor sometimes results in executions that don't occur or executions with inflated prices. How many times have you bought a call in the first few minutes of trading, only to have the underlying climb but your call decrease in value? Two things are going on: those who are handling the trades have to manage their own risk and they're going to do that by widening the spreads a bit in some cases, especially if they're uncertain about market direction. Also, if traders are flooding the markets with first-thing-in-the-morning orders, the whole supply/demand thing comes into play and prices get pumped up, too. No one is against us or trying to make suckers out of us. It's the way it works.
However, I'm a spread trader and I have a little different idea than Sheridan. For example, imagine that markets have been climbing for days and I've been being patient, waiting for the best time to swing the bear call portion of a condor above the markets, the time when I think the underlying might have hit the tippy top of that particular swing higher and ready to tip right over. Then imagine that I see an early move hit extreme measures. I'm likely to go ahead and throw out my order in case markets are about to reverse.
In addition, in that amateur hour period, prices are sometimes hopping around everywhere, and I sometimes find my orders get filled for a credit I'd asked for but not truly expected to get.
But buying an unhedged long call or put position during amateur hour? That shouldn't be done unless you expect a move big enough to overcome the perhaps inflated price you're paying. Great trade- and account-management practices should be instituted, too, in case an early move is reversed.
So, trade at your own risk during amateur hour, but do take advantage of its
peculiarities if you understand them and know what you're risking.