How To Make Money On Options Using Theta Decay
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.
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.
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 reason an option trading system using theta decay analysis works is because there is a more perfect information system in place for options than stock issues. Option trading is a more information efficient market because of the expiration date. Keen traders who keep up with the information flow can stand to make big gains from a system using this analysis.
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.
Imagine, for example, that you have an option approaching expiration and hold a short position while also selling an inverse call option. You could realize two separate gains. The first of these comes when you sell the call at a premium relative to its actual value. The second can result if the option does not finish on the positive side in money.
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.
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.
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 reason an option trading system using theta decay analysis works is because there is a more perfect information system in place for options than stock issues. Option trading is a more information efficient market because of the expiration date. Keen traders who keep up with the information flow can stand to make big gains from a system using this analysis.
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.
Imagine, for example, that you have an option approaching expiration and hold a short position while also selling an inverse call option. You could realize two separate gains. The first of these comes when you sell the call at a premium relative to its actual value. The second can result if the option does not finish on the positive side in money.
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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