Making Cents From Theta Decay You Can Do It Too
There are as many option trading systems out there as there are bright young traders looking to make a buck. Unfortunately, not all systems are made equal. Choosing the wrong one, or using it incorrectly, could lose you a substantial chunk of your hard-earned capital.
One system that can be effective when practiced correctly is theta decay. Don't be intimidated by the fancy name; the underlying concept is actually quite simple. The system is based on a fact that all option traders know: options expire on a specific, known, date.
Because option trading instruments have a finite life span, their value would tend to change as they come closer to the strike date. In analyzing trends in trading of options, the spread of prices that exist between the issuance date and the strike date is shown to get smaller as the issue nears expiration.
The specific expiration date of options is that gives theta decay its edge. Unlike stocks, the options market has a constant and, to some, dizzying flow of information. For traders who are able to keep up with that flow, big gains await.
How does one benefit from theta decay in their stock option trading system? The answer is simple - you take advantage of the time value of money, and its tendency to change faster closer to the expiration date. Analysis shows that the time value of an option drops linearly until the last thirty or so trading days prior to expiration.
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.
One system that can be effective when practiced correctly is theta decay. Don't be intimidated by the fancy name; the underlying concept is actually quite simple. The system is based on a fact that all option traders know: options expire on a specific, known, date.
Because option trading instruments have a finite life span, their value would tend to change as they come closer to the strike date. In analyzing trends in trading of options, the spread of prices that exist between the issuance date and the strike date is shown to get smaller as the issue nears expiration.
The specific expiration date of options is that gives theta decay its edge. Unlike stocks, the options market has a constant and, to some, dizzying flow of information. For traders who are able to keep up with that flow, big gains await.
How does one benefit from theta decay in their stock option trading system? The answer is simple - you take advantage of the time value of money, and its tendency to change faster closer to the expiration date. Analysis shows that the time value of an option drops linearly until the last thirty or so trading days prior to expiration.
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 stock option investing and provides a complete and detailed option trading course for beginners to experts.
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