Time Decay is your best Friend
We benefit from options because of Time Decay. Time decay is represented by a Greek term know as Theta. Don’t worry too much about the Greeks for now, we will take a look at it a later on.
Theta is a crucial component for options traders that decide to sell options. They will receive options premium to take on risk. And the out of the money option will loose money when time passes. We will choose options with high implied volatility. These options do have much option premium.
How to profit from Theta Decay
How does theta decay or time decay work? As we saw from the previous article on Extrinsic Value (also known as Time Value), or time to expiration has a huge impact on the price of the option. That is, as the option moves closer to expiry. When the options is running out of time it decrease more and more every day. As you can probably imagine, predicting an approximate stock price becomes easier very day. For example, you will have a much greater chance of predicting tomorrows closing price for Microsoft than you will of predicting next Fridays closing price.
Because of this, the Time Value of an option decreases exponentially as the maturity date approaches – especially as the time to maturity passes the 30 day mark.You can easily make money when options expire.
Below is what the theoretical value of an option looks like as time passes.
As you can see, after the 30 day mark, an option will begin to lose its extrinsic value quite rapidly. For out-of-the-money options this is key, as the entire option is made up of Extrinsic Value. You benefit from options decay if you have positions on with positive theta.
Read more on optiontradingtips
How to trade time decay
You can watch a video of time decay. We prefer to sell options for premium with time to expiration around 25 until maximum of 50 days. This seems to be the optimum time period for selling options.
Note that if you are long options, your position has negative time decay (negative Theta). If you are short options, the position has positive time decay (positive theta). We prefer to sell options and receive options premium. When time passes options value will decrease because of time decay. And we can buy the option back for a smaller credit.
Theta – Sensitivity to Time Decay
Theta measures the time decay of an option – the theoretical dollar amount that an option loses every day as time passes, assuming the price and volatility of the underlying remain the same. Theta increases when options are at-the-money; theta decreases when options are in- and out-of-the money. Long calls and long puts will usually have negative theta; short calls and short puts will have positive theta. By comparison, an instrument’s whose value is not eroded by time, such as a stock, would have zero theta.
Read more: Nasdaq.com
Use (Theta) Time Decay to Your Advantage
I have found a good video on youtube on selling options and profiting from options decay
Summary of Time decay
Options are a phenomenal tool. There are tons of benefits you can’t get in stocks or other investment vehicles. But, like anything, there are things to watch out for.
But once you know what to look out for, you may find that you can use it to your advantage, ultimately making it one of your biggest benefits.
One thing is sure, if you sell options that are out of the money, they will expire worthless. Choose to sell options for premium which has a strike price that is OTM and have enough option premium. Learn how to choose the right strike selection.
I trust that you like to article about Time Decay. We like to sell option premium. You also would like to read the article to make money when options expire.