Hey everyone this is Kirk here again at optionalpha.com and in this video we're going to go through
the question of how far out should I place trades.
Generally speaking we prefer shorter duration or timeline trading whenever possible.
Meaning we prefer always to hold trades as short of an amount of time as possible, but
it doesn't necessarily mean that the shortest time period is the best, it just means that
we do prefer to hold trades for as little as time as possible and not have money exposed
and at risk.
Right now at the time we're doing this video, our average holding period for all trades
that we have is 27 days.
That's the amount of time that we're holding each trade on average.
We could enter a trade, let's say, 60 days out and close it after it's been working for
30 days.
So we still have 30 days left until expiration but we closed it and held it for 30 days after
entering the trade for 60 days, or 60 days out.
For us that's usually about a pretty good average of where we want to be around.
We kind of want to be around that 30 area so we're holding trades a little less than
average right now, which is good.
You can always check our updated performance on the live portfolio stats page right on
Option Alpha.
Now whenever we determine how far out to place trades though, when we're looking at new strategies,
we should be mindful of how an option's price is affected by Theta and Vega.
Before we get into some examples, I want to go through another reminder, in case you don't
know, or in case you do know, it's probably helpful to understand it again.
The impact that time decay and Theta and volatility or Vega has on an option's price.
Now remember that as we near expiration, so as we get closer to an expiration, so we're
60 days out, 90 days out, 30 days out, et cetera.
An option's price is going to go down in an exponential fashion.
It's going to very slow as it's further out and then as it nears expiration, the rate
at which the value declines, in the option's price, is going to speed up exponentially
until it hits 0 at expiration.
Again this is that extrinsic or time value of an option and mainly this is derived through
Theta and Vega, or volatility.
The sweet spot is really somewhere around 40 to 45 days here.
That's when time decay is at it's optimal rate, it starts really accelerating at an
optimal peak.
That's ideally where we want to be placing a lot of our shore premium trades is around
that 40 to 45 day mark.
Again, it's just important to understand how time decay affects an option's position.
Likewise it's also important to realize that implied volatility or Vega has an impact depending
on how far out an option's expiration date is.
If we're looking at 2 different contracts, 1 contract has 30 day until expiration, if
that option contract costs $1.50, that Vega in that contract or the volatility impact
of just a 1% move up in implied volatility, might only be $3.
It's 30 days away, so a large jump in volatility, let's call it 3, 4, 5% is not going to impact
the value of that option that much, because each 1% move up in implied volatility only
impacts the value of that option by $3.00.
So the closer you get in timeline, the smaller the impact of rising implied volatility or
really falling implied volatility is as well.
As you get further out in timelines, let say an option that's really far out, just to kind
of prove the point here, 365 days out ... The option may cost, on the outside, $536 because
of the time that's added in there, you might be looking at a Vega of 0.2.
That same 1% move up in volatility now has a much more dramatic impact on the option's
value in the future, because it's going to be spread out over a longer period of time.
That volatility is going to have 365 days to now play out versus 30 days to play out.
It's important to understand this concept.
As we hear Option Alpha look at an option's timeline, out into the future, 1 day being
1 day until expiration, 30, 30 days until expiration, 60, and then everything kind of
beyond 60.
Our sweet spot, like we talked about before, is right around 45 days to place a trade.
Placing a trade around 45 days mainly as option sellers, which we are, that's usually what
we want to be doing, is placing trades around 45 days and then more often than not, we close
them out somewhere around 15 days.
I think this is an important concept, because we do manage a lot of our trades early, we
do close them early.
We are deliberately trying to close positions and take profits early, which means that we
don't typically hold a lot of our portfolio in closer to expiration, which means that
we're not subject to a lot of assignment expiration risk, holding a lot of positions all the way
to expiration.
If we need to hold a position through expiration, to see if it works, we will, but we don't
like to do that, we don't generally do that, as a course of trading in business.
Most of our stuff is placed around 45 days, and then closed around 15 days.
Some stuff might be placed at 45, closed at 30, et cetera, et cetera, et cetera.
The way that you want to think about you're options trading, in general, is that everything
basically around the 25 to 40 day mark is really the sweet spot for option selling.
This is where you want to be doing a lot of your option selling strategies, or net selling
strategies.
The reason that you want to do that is because during this window, time decay is at it's
highest peak, or is increasing at it's fastest rate, every single day, and because the impact
of being wrong on volatility, meaning that if we're an options seller and volatility
goes up, that's a bad thing for us.
The impact of volatility going higher is going to be very very small on our positions.
The negative impact of being wrong directionally volatility, which we should be pretty right
in our directional assumption of volatility, if we know that implied volatility is high
and we're going to be option sellers.
If we are wrong and our option volatility goes even higher, that impact is going to
be as small as possible, and mainly offset by the fact that time decay is increasing
at an exponential rate.
If we are looking to be option buyers, then at that point we really be kind of working
45 days plus.
I say even go out to, say, 60 or 70 days out.
For us, really 80 days out might be too far.
That might be really too far on the further extremes and edges, but really we want to
be working 45 days to 60 days or so, maybe 70 days out for how far out to place trades.
Again, when you are buying options, and the reason that we want to do that now, is that
think about your strategy heading into an option buying scenario.
You are hopefully looking for an increase in volatility, or a move up in volatility,
or you wouldn't be buying options, assuming that they're already, their implied volatility
is already low.
You also want to, realizing that your option is a wasting asset.
If you bought an option for let's say, $1.50, you want to make sure that it's worth more
than $1.50 at the time that you close out the position.
If time decay is a big factor, and is slowly eroding the value of that option, then we
want time decay's impact to be as minimal as possible.
That's why on these option trades where we're a little bit further out, we want to have
a small impact of time decay against our option, and we want to have as large of an impact
as possible on being right in the directional move of volatility.
The further out that our initial position is, the greater that implied volatility will
be a profit maker for us in that strategy.
We want to play towards the strengths as we look at the timeline for placing trades.
Generally speaking, if we look at it graphically and with different strategies, we generally
want to be placing trades like strangles and iron condors and straddles.
All of our shore premium strategies we kind of want to be centered around this 25 to 45
day window.
Anything really longer than that, anything further out than that, we want to be doing
the long option strategy.
These are ratio spreads, debit spreads, calendars would be in this category as well.
You want to be doing those out a little bit further.
Remember, option pricing is cheap, so we want to lock in the timeline, as much time as possible
to be right, in our directional assumption, when option pricing is cheap, and we can do
those net buying strategies, like doing ratio spreads and debit spreads, et cetera.
We want to make sure that we're always cognizant of that time period.
We do have a free ultimate strategy guide right here at Option Alpha.
It breaks down every single option strategy that we use, and the optimal time period to
enter that position.
I would encourage you to check it out, again it's totally free, you don't have to pay for
it, we wrote that guide, it's been recently updated.
It basically tells you, if you're going to do an iron condor trade, you want to place
it xyz days out into the future, or if you do a ratio spread, you're going to want to
place it xyz days out into the future, as your optimal entry point.
As much as possible, let's always play to the strengths of the market.
Let's realize that when volatility is high, and we can come in a little bit closer, and
time decay is on our side, or increasing at an exponential rate, we want to option sellers,
versus the alternative.
As a general rule here, we want to be net buyers when our smallest edge is present in
the market.
Meaning when volatility is lowest, we want to be net buyer.
If we have a small edge, therefore we need to compensate for that small edge that we
have in pricing, by trying to get more time, or a longer duration trade.
Meaning entering the trade with 60 days, so that it has 2 full months to maybe swing into
the direction that we need it to, before we end up taking the trade off for a profit.
If we want to be net sellers, we realize that we have the largest possible pricing edge
right at that moment because implied volatility is high, therefore we want to force the market
to make a move that's out of the ordinary.
Meaning we want to enter our trades with generally less time, so around 45 days is the starting
point is how we do that.
That's the optimal point.
Does that mean that if we get into a trade, and the contract months are, let's say the
closest contract month has 41 days that we won't trade it?
No, of course we'll trade it at 41 days.
We ideally love to do it around 45 days but we'll do something as low as say 25 days in
time.
So somewhere around that 27 to 30 days, that we were talking about earlier.
Remember, our edge is greatest, we want to force the market to make a move that's out
of the ordinary, and basically turn our position from a profit into a winner.
That's why I love option selling so much, is because you force the market to make a
move it's doesn't normally do, versus trying to buy as much time, as a net buyer, you try
to buy as much time as possible to hope that you're right, and that the market swings into
your favor.
This is really key.
Net buyers, you want to do more time, longer duration , or longer timeline trades.
Net sellers, or net selling strategies, you want to have less time to force the market
to make a move that it doesn't usually do.
As always, hope you guys enjoy these videos.
If you have any comments or questions, please leave them right below in the comment box.
If you have any feedback, or anything that you want me to discuss as strategy, ask it
right below in the comment section.
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to do here at Option Alpha, and until next time, happy trading.