It’s a Matter of Time

A key component of options is time value, one the Greeks referred to as theta. An option contract is like an ice cube; time melts it away. Every day, little by little, your option contracts are worth a little less. Like an ice cube, the closer you get to expiration, the faster it melts.

There are great strategies in selling premium, and hence, time. But with the way we trade, we buy first, then sell. You may be wondering why we don’t simply sell premium. Essentially, when you sell premium, there are other risks involved that most of us would rather avoid.

One such risk is being obligated to cover for the underlying stock should the trade turn against us. Because each contract controls 100 underlying shares, at roughly $472 a share, a single contract can commit you to $47,200. Don’t have that in your trading account? No problem: your broker will lend it to you. You know where that is going.

With the way we trade — buy first, then sell — you can only lose what you pay for. Just remain vigilant about time, as it is not on your side.

Theta loss works exponentially on our premiums. As a result of the faster erosion close to expiration, I always buy plenty of time. It lessens the theta loss stress.

As a comparison, buying “at the money” options that expire soon have a much higher theta loss. They are cheaper in price, but there is a reason for that: they have higher risk. You can certainly do very well if the stock moves in your direction. However, should the stock reverse on you, that premium is sucked away faster than Taylor Swift can change outfits on her Eras Tour. Market prices can and do shift quickly, and the anxiety they create is not worth the risk. One bad trade can wipe out many days of gains.

Conversely, buying time significantly reduces that theta loss. Options do cost more, but what most traders don’t realize is that you can get it all back when you sell anyway. So, it really doesn’t matter. Simply buy fewer contracts for the same investment you would have paid for the cheaper options.

Buying too far out on expiration, however, leaves you with less profit potential as the options do not move as quickly. The delicate balance, I find, is to buy this week’s Friday’s expiration if today is a Monday or Tuesday. If it is Wednesday through Friday, I like to buy the following week’s Friday’s expiration.

I am often asked why buy time when I plan to sell my options within minutes after buying. The reason to buy time is to relieve the undue pressure on us with same-day or soon-to-expire options.

Some analysts claim 40% of options trades are on zero days to expiration (0 DTE) contracts. In other words, there is no tomorrow. They are definitely attractive as they have a lesser upfront commitment. This is why most people engage with them. That tells me traders are akin to gamblers, or they simply do not know the perils of short-term expirations. This explains why 95% of traders opt out of the business within a year. Are you prepared to take that risk on short-term expirations? I certainly am not.

Despite planning on selling right away, it doesn’t always work out that way. If I need to hold longer, even longer during the same day, it is comforting to know that I have ample time left.

Buying time is buying piece of mind. Let the gamblers trade same-day expirations. Most of them will be gone the moment their options vanish into the ether.

Knowing this, could you become a better trader now?

We teach this strategy and much more in our daily Trading Room. Invest in yourself first, then the market. Heed this one and only guarantee: you WILL lose your money if you do not understand options.

Take wisdom and experience from long-time traders. Ahren and I have over 40 years market participation between us. This is sold gold; you just have to mine it. We open up our facilities every morning, from 9:20 to 10:30 a.m., ET for you to pick our brains. Learn about time and everything else you need to know about day trading options. Click here to subscribe to the Trading Room today and be online tomorrow!

By the way, Taylor Swift changes outfits, on average, in one minute, eight seconds.