Theta Decay - Using Time To Make Money With Options
For many market traders, looking for a trend or some other market anomaly in order to consistently make money is the financial holy grail. Though there are a number of market systems that claim to be consistent enough to make you money, the reality is that most strategies aren't as trustworthy as they could be, which can cause you to lose your hard earned capital.
Theta decay is one much-hailed example of such systems. The name itself is surely impressive. The fact is, though, that theta decay rests on a very fundamental concept in option trading the fact that options expire on a set date.
One result of this is that option values change over time. In particular, they change significantly when their expiration dates are drawing near. For example, options traders have learned that option values tend to drop as the strike date approaches.
Theta decay analysis is able to serve as the basis for an option trading system because, compared with stocks, options are much more information-rich. The existence of an expiration date gives options traders the information foothold they need. Big gains can result for those able to keep up with the brisk flow of options information.
Actually, it's not that difficult to use theta decay techniques to cash in on those gains. Remember the fundamental concept: the closer the expiration date is, the faster the time value changes. In particular, studies show that the time value of an option decreases according to a linear trend until approximately the last thirty trading days prior to expiry.
During that final month of trading days, theta decay techniques come into their own. It is during that time period when the time values start to drop even more precipitously. By holding the right positions, however, you stand to make money on that fall.
For example, you could hold a short position in an option approaching expiration while simultaneously selling an inverse call option. This benefits you in two ways. First, you reap a benefit if you sell the call at a premium compared to the actual value. Second, you can also realize a gain on the short position, assuming that the option does not finish in the money on the positive side.
If you get your timing right and keep an eagle eye out for option information, theta decay is a useful tool to employ with your stock options trading. As with any system, there is always the possibility of losing your principal through incautious application of the technique. However, if you are attuned to the market and carefully scrutinize expiration dates, you can easily find yourself making money with this effective and under-utilized strategy.
Theta decay is one much-hailed example of such systems. The name itself is surely impressive. The fact is, though, that theta decay rests on a very fundamental concept in option trading the fact that options expire on a set date.
One result of this is that option values change over time. In particular, they change significantly when their expiration dates are drawing near. For example, options traders have learned that option values tend to drop as the strike date approaches.
Theta decay analysis is able to serve as the basis for an option trading system because, compared with stocks, options are much more information-rich. The existence of an expiration date gives options traders the information foothold they need. Big gains can result for those able to keep up with the brisk flow of options information.
Actually, it's not that difficult to use theta decay techniques to cash in on those gains. Remember the fundamental concept: the closer the expiration date is, the faster the time value changes. In particular, studies show that the time value of an option decreases according to a linear trend until approximately the last thirty trading days prior to expiry.
During that final month of trading days, theta decay techniques come into their own. It is during that time period when the time values start to drop even more precipitously. By holding the right positions, however, you stand to make money on that fall.
For example, you could hold a short position in an option approaching expiration while simultaneously selling an inverse call option. This benefits you in two ways. First, you reap a benefit if you sell the call at a premium compared to the actual value. Second, you can also realize a gain on the short position, assuming that the option does not finish in the money on the positive side.
If you get your timing right and keep an eagle eye out for option information, theta decay is a useful tool to employ with your stock options trading. As with any system, there is always the possibility of losing your principal through incautious application of the technique. However, if you are attuned to the market and carefully scrutinize expiration dates, you can easily find yourself making money with this effective and under-utilized strategy.
About the Author:
TheScienceOfTrading.com provides 90 free minutes of videos on option trading tips and provides a complete and detailed option trading course for beginners to experts.
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