Last Update: August 2021
≈ Understanding the role of Theta ≈
Traders,
One of the most important concepts to understand in options trading is Time. Time passing will either help an options trade or hurt an options trade depending on what type of trade it is.
An options value is first understood as simply a price. If you buy a call option for $3.00 per contract you will pay $300 total for the call. The call option gives you the right to buy 100 shares of an underlying stock at or before a set date (expiration date) at a specific price (the strike price).
Buyers of options, like calls, carry negative time implications. This is called Theta and knows as time decay. Every day that passes you lose a little bit of the value from this reality of time passing. Whether your $300 trade goes up in value and you earn a profit will be dependent on the stock moving in your favor, as you are fighting time passing.
Option sellers use strategies like short puts (naked or cash-secured), Covered calls against shares they own, and option spreads like Bull Puts, Bear Calls, and Iron Condors to generate positive Theta and time decay. These strategies are important and valuable in many market conditions – particularly markets that become range-bound and trendless. But, in any market, some traders use Theta trades as a primary source of their strategy selection to generate ‘Cash Flow’.
We call this style of trading ‘Theta’ and we have dedicated a section of our Tackle Trading Playbook to help you learn how to build Theta trades with rules from our coaches. If you’ve never studied some of them, you can review the playbook here (PRO Members Only).
If you’re going to trade Theta strategies, you will need to understand how much time to sell in your options, how it will impact the way you trade, and how to determine a good trading candidate from a poor trading candidate.
Many traders will use a combination of Delta, Theta, and Vega strategies to build their Trading Plan for their capital. What type of trader are you? Take some time to build your system, through rules and proper design.
Spend some time studying Theta, and see if there’s a role in your trading for some of these Cash Flow strategies.
#TeamTackle
Chart of the Day: Time Decay Curve
Options time decay is non-linear. Each day that passes has its own amount of time decay. The further in time you are out the less time decay per day. The closer you get to expiration date for the option, the higher amount of time decay per day. Many traders will buy longer-term options when they are trading directionally and sell shorter-term options when they are trading for cash flow from time passing.
Video of the day: Time Decay
Coach Tim answers a question from a #TeamTackle student about the impact of Time Decay.
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