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How To Make A Full-Time Income Trading Less Than Part Time

Big Dogs Exposed

Sound familiar? You have spent years surfing the 'Net, and studying books and charts in search of the straight skinny on commodities futures trading strategies, options trading, or successful stock market trading strategies. All you really want is the 'Holy Grail' of entry techniques. You usually end up adding one indicator on top of another, switching from one guru to the next, until you are so confused and unsure of your entry system that you are unable to make entry decisions and stay organized. You get so distracted and frustrated that you quit watching the markets all together!

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Newsletter: Options - Time Decay

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Options -Time Decay

As time marches on, the time value premium of an option decreases, until the option itself eventually expires worthless.

Time value, or ‘extrinsic value,’ is the difference between the current market price of an option and its intrinsic value. ‘Intrinsic value’ is the amount an option is in-the-money. Accordingly, out-of-the-money and at-the-money options have no intrinsic value - just time value. Four things influence time value - interest rate, liquidity, time to maturity and volatility of the underlying asset.

The time value of an option erodes quickly as it approaches expiration. The closer an option is to expiring, the more value it loses, assuming the market doesn't move in the direction that puts the option in-the-money.

At expiry, an option is only worth its intrinsic value – i.e., it's either in-the-money or it’s not. The effect of time decay is greatest in the last 30 days of an option’s life. Obviously, the further out from expiration an option is, the lesser the impact of time decay.

Let’s suppose you just purchased long options. If the underlying stock goes sideways on you, you are susceptible to time decay in the options. The options lose value, as each day goes by without any movement in the stock’s price. The further out from expiration, the smaller the loss. To minimize the effects of time value, use options with as much time to expiration as possible within reason, taking into account your original risk/reward assessment.

Whether it be a long call or a long put, you want to have as much time as possible for your option to move ‘into the money.’ And, you also want to lessen the impact of time decay, in the event the underlying stock moves sideways for awhile.

Don’t be tempted to buy ‘cheap.’ By that, I mean when you sense a stock is about to make its move, you will invariably fall into the trap of buying options with less than 30 days to expiration, simply because they’re cheap. Use long-term options to reduce the effect of time decay. This will allow you to wait out the expected move in the underlying stock patiently, without watching your money or position suffer in the meantime.

You can also use time decay to your advantage by selling options. When you sell options, your objective is for them to expire worthless, or to buy them back at a lower price for a profit.

Here you would want to sell shorter options, with less than 45 days to expiration. Time decay, in this case, would work in your favor, because a short-term short option decreases the option's value, thereby producing a profit for you the short seller.

(Credit: Optionetics)

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How To Make A Full-Time Income Trading Less Than Part Time

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