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This leads me to believe the market may be stuck in no-man’s land. And third, we are coming up on a double whammy for options prices. Here is what I mean by that: As I have written in the past, options prices get hit hard as one expiration cycle expires and a new options expiration becomes the front month. And this week, January options will cease to exist, and February options will be the front month. The reason for this? Let’s say you were long stock in Facebook (FB) and short a January call against it. This is the typical buy-write/covered call position. As the January call you are short expires you would look to sell a new call against your FB stock position. However, Jacob the market maker knows that this trade is coming from individual traders and from institutions. So, as the market maker, I would start lowering the price of the February options ahead of time so that I will be buying at a cheaper price when others are selling. Then, on top of that throw in the upcoming long weekend. The stock market will be closed on Monday, January 21st for Martin Luther King Day—a nice three-day weekend. But it’s not generally good for options prices. Over the course of the next couple of days, the market makers, or more likely their computer systems, are going to “push the date ahead” in all their products. So in the market makers’ pricing models, tomorrow’s date won’t be January 17th, it’s more likely to be January 21st. And as we get closer to this weekend, the computer models will move the date to January 22nd, which is the day the market opens after the holiday. The models do this to price in the decay of the day off for the holiday. That means that they will take virtually all of the decay out of the options ahead of time so that they aren’t stuck being the buyer of decaying assets over a long weekend. So how do we profit from this phenomenon? By selling options via buy-writes or option spreads like an Iron Condor. Here is the breakdown of a short volatility trade known as an Iron Condor which could work well ahead of a long holiday weekend: The Iron Condor position is the combination of a bear call spread and a bull put spread in the same underlying. It’s a strategy that’s a high probability trade, allowing for a modest profit with enough room for error. Also, it’s meant to be a directionally neutral trade, used when volatility is elevated in relation to its forecasted range. It’s my favorite volatility selling strategy. By selling a call spread and a put spread, you gain extra short volatility and decay, while at the same time limiting your risk. Here’s the hypothetical call spread: Stock XYZ is trading at 90. You’d theoretically sell the 100/105 bear call spread for $1. To execute this trade, you would: Sell the 100 calls Buy the 105 calls For a total credit of $1. Here is the graph of this trade at expiration. Here’s the hypothetical put spread: Stock XYZ is trading at 90. You’d sell the 85/80 put spread for $1. To execute this trade you would: Sell the 85 Puts Buy the 80 Puts For a total credit of $1. Here is the graph of this trade at expiration: Now we will combine these two spreads to make an Iron Condor: To do this, you simultaneously: Sell the 100 calls Buy the 105 calls For a total credit of $1. And Sell the 85 Puts Buy the 80 Puts For a total credit of $1. This would give you a total credit of $2. Here is the graph of this trade at expiration: As you can see in the chart, at expiration, you’d make $2 as long as the stock stays between 85 and 100. Meanwhile, your downside is limited to $3 if the stock goes lower than 80 or higher than 105. To learn more about these strategies and Cabot Options Trader where I use these strategies to create profits in any market visit Jacob Mintz or optionsace.com where I teach and mentor options traders. Your guide to successful options trading, Jacob Mintz
In other words, an option premium that is not intrinsic value will decline at an increasing rate as expiration nears. The Theta is one of the most important Options Greeks. Negative theta vs. positive theta Theta values are negative in long option positions and positive in short option positions. Initially, out of the money options have a faster rate of theta decay than at the money options, but as expiration nears, the rate of theta option time decay for OTM options slows and the ATM options begin to experience theta decay at a faster rate. This is a function of theta being a much smaller component of an OTM option's price, the closer the option is to expiring. Theta is often called a "silent killer" of option buyers. Buyers, by definition, have only limited risk in their strategies together with the potential for unlimited gains. While this might look good on paper, in practice it often turns out to be death by a thousand cuts. In other words, it is true you can only lose what you pay for an option. It is also true that there is no limit to how many times you can lose. And as any lottery player knows well, a little money spent each week can add up after not hitting the jackpot for a long time. For option buyers, therefore, the pain of slowly eroding your trading capital sours the experience. When buying options, you can reduce the risk of negative theta by buying options with longer expiration. The tradeoff is smaller positive gamma, which means that the gains will be smaller if the stock moves. Option sellers use theta to their advantage, collecting time decay every day. The same is true of credit spreads, which are really selling strategies. Calendar spreads involve buying a longer-dated option and selling a nearer-dated option, taking advantage of the fact that options expire faster as they approach expiration. You can see the accelerated curve of option time decay in the following graph: As a general rule of thumb, option sellers want the underlying to stay stable, while option buyers want it to move. List of positive theta options strategies Short Call Short Put Short Straddle Short Strangle Covered Call Write Covered Put Write Long Calendar Spread Vertical Credit Spread Iron Condor Butterfly Spread List of negative theta options strategies Long Call Long Put Long Straddle Long Strangle Vertical Debit Spread Watch this video: Related articles: The Options Greeks: Is It Greek To You? Options Trading Greeks: Vega For Volatility Options Trading Greeks: Delta For Direction Options Trading Greeks: Gamma For Speed Want to learn how to put the Options Greeks to work for you? Start Your Free Trial
Since the markets are closed Monday, can we expect extra theta decay today to account for the long weekend? I have read conflicting opinions in various places. Both SNDK and FFIV look like good candidates for a straddle, but 3 days of theta might change the picture. Thank you. Mike