Theta Decay - Using Time To Make Money With Options
As you're probably aware, a number of market systems exist that claim to be sure money makers. That shouldn't be surprising given the number of market traders expending time and effort on developing systems to capitalize on trends and anomalies within the market. But not all these systems are as reliable as they claim to be. Smart traders will choose carefully, or watch their hard-earned capital drain away.
A widely touted stock option trading strategy out there in common use today is the idea of "theta decay." At first glance, the name isn't indicative of something positive, but in reality, the concept capitalizes on a well known fact about option trading - options expire on a set date.
This means that options do not have a fixed value. Instead, their value changes as the expiration date draws near. Analysis of option trading trends shows that price spread is greater closer to the issuance date. As the strike date approaches, the spread decreases.
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.
Ultimately, with good timing and keen senses for information gathering, you can use theta decay as part of your stock option trading strategy. Of course, there is always the risk of losing your principal if you're not careful, but if you can read the market well and pay attention to expiration dates of options, you too could make money from this not so well known but obvious market strategy.
A widely touted stock option trading strategy out there in common use today is the idea of "theta decay." At first glance, the name isn't indicative of something positive, but in reality, the concept capitalizes on a well known fact about option trading - options expire on a set date.
This means that options do not have a fixed value. Instead, their value changes as the expiration date draws near. Analysis of option trading trends shows that price spread is greater closer to the issuance date. As the strike date approaches, the spread decreases.
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.
Ultimately, with good timing and keen senses for information gathering, you can use theta decay as part of your stock option trading strategy. Of course, there is always the risk of losing your principal if you're not careful, but if you can read the market well and pay attention to expiration dates of options, you too could make money from this not so well known but obvious market strategy.
About the Author:
TheScienceOfTrading.com provides 90 free minutes of videos on option trading systems and provides a complete and detailed option trading course for beginners to experts.
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