Wow, what a remarkable rebound in stocks… and by the looks of it the “buy the dippers” are winning the battle.
At these levels, who really knows what’s going to happen next. The only thing I know is I certainly don’t want to buy options, whether I think stocks continue higher or reverse from these levels.
Well, for the most part, options premiums have been juiced… but that’s not the problem I see with being a buyer of options. You see, if I purchase options, I believe I’m actually at a disadvantage…
On the other hand, if I use my risk-defined strategy to sell options, there are a few factors working in my favor — such as time decay.
So what is time decay and how does it benefit my options strategy?
[Revealed] One Factor That Options Sellers Benefit From
Of course, at first glance, buying calls or puts outright may seem easy. Heck, I actually was an options buyer before I uncovered the benefits of selling options spreads.
One of those benefits is time decay.
You see, when you buy options, those options actually lose value as each day passes. In other words, options buyers are fighting time.
Think about it like this let’s say you buy a gallon of milk… as each day passes and you don’t drink it, you would lose money. As it gets closer and closer to the expiration date, the amount you lose accelerates.
Time Decay Explained
With options, it’s kind of similar to that. However, the price of an option is broken into intrinsic and extrinsic value. Now, intrinsic value is the price of the option if it were to expire at a specific momentum in time.
An option needs to be in-the-money to have intrinsic value.For calls, that means the stock must be trading above the strike price… and for puts, the stock must be trading below the strike price.
The rest of the options premium is known as extrinsic value.
Any call option with a strike price above the current stock price is out-of-the-money. That means the entire cost of that option is 100% extrinsic value.
Extrinsic value wastes away every day that you own an option. Unless your trade moves quickly and significantly in your favor, you stand to lose.
However, selling an option spread works the exact opposite. Everything that works against an option buyer works for the seller.
Here’s a chart to show you how time works against an option buyer and for the seller.
As you can see, in the chart above, as the time to expiration decreases… the time decay accelerates.
On your options platform, you should be able to see the time decay… this would fall under the “Greeks”, and there should be “theta” listed. This tells you how much time value an option can lose as each day passes. However, keep in mind theta does not remain constant.
As each day passes, theta actually decreases more and more (it’s a negative value when you purchase options). On the other hand, as a seller of options, the theta would increase (it’s positive since you’re net short options).
That’s why I love to sell options spread.
Well, I don’t need the underlying stock to actually move in my favor. For example, if I enter a bull put spread, I’m collecting premium to establish my bullish opinion on the underlying stock.
Now, if the stock moves to my favor (runs higher), then I would be in a position to profit… if there’s choppy price action, I can still profit. Even if the stock falls a little, I can still profit. The one thing I need to happen is the stock to stay above a key level.
In the background, time is actually working on my side. As each day passes, I’m actually collecting a little bit of the premium (all else being equal).
Of course, there are other factors working to my favor when I use my “casino” strategy. If you want to learn why I believe I have an edge in the options market,check out my options trading eBook Wall Street Bookie.In it, I detail my Weekly Windfalls strategy and how I use it to my advantage.