Making Cents From Theta Decay You Can Do It Too
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.
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.
But how does one put theta decay to play in stock options trading? It's not as difficult as you might think. The key insight is that the time value of money changes faster as the expiration date approaches. Studies have found that an option's time value falls according to a linear pattern before reaching the last thirty or so trading days before its expiration date.
Those last thirty days are where this set of option trading strategies comes into full effect. As the issue gets closer within that thirty day period, the time value of the option starts to decline at an accelerated rate. As a result, if you hold certain positions, you can profit from this loss.
By holding a short position in an option that is close to expiration while selling an inverse call option, you can capitalize on the vale loss in a couple of ways. You can make money by selling the call at a premium to what the actual value is, and can make money on the short position so long as the option fails to finish in the money on the positive side.
As you can see, by tracking expiration dates and perfecting your timing, you can make theta decay a profitable technique. It is true, as with any system, that improper application of the strategy could lose you principal. But for those who have a good feel for the market and the ability to track option market information, theta decay remains a potentially lucrative and non-commonplace device worthy of being added to your market toolkit.
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.
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.
But how does one put theta decay to play in stock options trading? It's not as difficult as you might think. The key insight is that the time value of money changes faster as the expiration date approaches. Studies have found that an option's time value falls according to a linear pattern before reaching the last thirty or so trading days before its expiration date.
Those last thirty days are where this set of option trading strategies comes into full effect. As the issue gets closer within that thirty day period, the time value of the option starts to decline at an accelerated rate. As a result, if you hold certain positions, you can profit from this loss.
By holding a short position in an option that is close to expiration while selling an inverse call option, you can capitalize on the vale loss in a couple of ways. You can make money by selling the call at a premium to what the actual value is, and can make money on the short position so long as the option fails to finish in the money on the positive side.
As you can see, by tracking expiration dates and perfecting your timing, you can make theta decay a profitable technique. It is true, as with any system, that improper application of the strategy could lose you principal. But for those who have a good feel for the market and the ability to track option market information, theta decay remains a potentially lucrative and non-commonplace device worthy of being added to your market toolkit.
About the Author:
TheScienceOfTrading.com provides 90 free minutes of videos on option trading systems and provides a complete and detailed stock trading course for beginners to experts.
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12:39 AM
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