Theta is a Greek loved by cash flow traders everywhere. Previously we provided a four-part series exhaustively outlining his traits (see here, here, here, and here). I suggest starting with these earlier articles if you haven’t done so already. Then, return and relish in the powerful concept of Theta Targeting discussed below.

Theta Targeting

Rather than waxing eloquent with stories and such, I’m using a logic chain to build your understanding of Theta. This will allow us to progress incrementally until we’ve crafted a holistic understanding of Theta Targeting.

First, Theta measures the daily decay of an option’s value.

Second, traders who sell options have theta working in their favor; they carry positive Theta positions.

Third, we can add the Theta of each position together. If you have five trades, each with a positive theta of 10, then your total portfolio Theta is 50. That means, all else equal, you should gain $50 per day.

Fourth, the higher your portfolio Theta, the greater your daily profit potential due to the passage of time. A trader owning a portfolio of 50 Theta is harnessing the power of time decay better than a trader holding a portfolio with 20 Theta.

Fifth, the higher your portfolio Theta relative to other greeks, the greater the role Theta plays in determining your overall success. For example, if trader A has a portfolio Theta of 100, but his delta (beta weighted to SPY, of course) is 300, and his vega is 200, then time decay isn’t the primary driver of his P/L.

By contrast, Trader B has a portfolio Theta of 75, but his beta weighted delta is only 40, and his vega is 60. Even though the second trader has a smaller portfolio Theta, it is larger relative to the other greeks. Said another way, Trader B is relying more on Father Time to drive his profits than Trader A.

Sixth, traders who engage in “Theta Targeting” pick a number that they want to try to build their portfolio Theta to. If my Theta Target is 100, then I’m trying to sell enough options using various cash flow strategies so that my account theoretically generates $100 a day in time-based profits.

Okay, enough with counting. Now for a few final key points.

There isn’t one right number to shoot for. What’s appropriate for a $50k account would be reckless for a $10k account because you would have to sell too many options and likely take too much risk to achieve the target.

Theta doesn’t operate in a vacuum. It is a single cog in a complex machine. Just because your portfolio Theta is 100, doesn’t mean you will make $100 per day because you might lose due to adverse movement due to delta or vega. Nonetheless, it can still be valuable in setting a target and amplifying your Theta number as much as possible, given your risk rules.

It will take some trial and error to identify what’s an ideal number for your portfolio amount, but once you do, you can create more realistic expectations around it. Start with a small Theta number and increase it as you get comfortable managing more positions simultaneously.