Options Greeks explained: What is theta? How can I avoid options time decay? // Options trading 101 welcome to looking at the markets with David Moadel today's topic is options
Greeks explained what is Theta and how can I avoid options time decay
alright so the specific Greek that will be discussing today is Theta also known
as time decay and if you're an options purchaser if you buy calls or a few buy
puts we all know that or at least we should know that theta is not our friend
it can be our enemy if where the owner of a collar put so how can we avoid it
how can we minimize the effects of time decay let's talk about it
first a quick definition or review what is Theta while theta is how much value
an option
a caller put will lose each day due to time decay theta is generally expressed
as a negative number so for example an option with a theta of negative . 15
will lose fifteen cents per day due to time decay which equals fifteen dollars
per day if you own one option contract because remember one option contract is
the equivalent of 100 shares of the stock or ETF or commodity or currency or
whatever
like other options Greeks theta constantly changes just because the
theta of an option is negative . 15 today doesn't mean that it will be that
number tomorrow or or even in five minutes for that matter
it's constantly changing and I put a picture of a melting ice cube because
that's what theta does to your option to your caller put contract it gradually in
the beginning it gradually eats away at the value or reduces the value or price
of your option contract and as we get closer to expiration the expiration date
it melts even faster
so what can we do in order to minimize the effects the negative effects of
theta or time decay when we purchase an option we cannot avoid time decays
negative effects completely of course especially as we get closer to
expiration data is going to have a greater and greater negative impact on
our purchase options but here are four things we can do in order to at least
minimize or reduce the negative effects of of theta when we purchase an option
the first point is that shorter-term options tend to have higher theta
then longer-term options remember higher theta or greater theta
is is not a good thing when we purchase an option
or when we own an option so i recommend buying calls and puts with plenty of
time until expiration between three and six months is my preference but you can
go even longer
of course if you're if you have more money to spend you can buy even more
time premium than that
options for high volatility stocks or ETFs commodities or whatever tend to
have higher theta and options for low volatility stocks so i recommend buying
calls and puts when volatility is low
the third thing you can do well options options that are nearest to the money in
other words the strike price is close to the current price of the stock or
whatever
and particularly at the money options will typically have the highest theta so
i recommend buying calls and puts that are in the money instead of at the money
okay
and the further in the money really the better or it i mean within certain
limits you don't have to go too far into the money
but if if you can go a couple of strikes in in the money
that can reduce the the theta which will benefit you as an options purchaser or
owner at least in the money can be better than at the money I and finally
using vertical debit spreads which very simplified explanation is buying a more
expensive option and then also selling a less expensive option with the same
expiration date and and for the same underlying asset you know for the same
stock or whatever
using vertical debit spreads can reduce the effect of time decay even more
ok and you can do you know one of these things or a combination in fact
oftentimes I'll do all four of these things in order to reduce the negative
impact of theta or time decay when I purchase an option so here's the
takeaway time decay isn't your friend when you're buying options it is not
your friend
if you stick to these guidelines however you can make data less of a factor in
your options value and if you'd like help with buying options or stocks or
just if you want to put together a trading plan or investing plan I can
assist you with that
my name is David Modell
and my email address is David Modell and the last name is spelled and OA de l @
gmail.com and you can email me anytime and i'll be sure to get back to you know
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so thank you so much i hope this was helpful and i'll talk to you soon