Date: 5/27/2022
Author: Chris Hood
Be sure to check out new episodes of my video podcast each week, where my ace pupil Brian Jones and I talk the ins and outs of options trading- and give you insights and strategy that you can immediately put to work for you in the markets.
I get so many questions from subscribers and clients every day it’s hard to pick a topic to write about.
Options can be daunting for the beginner.
I understand that. Remember, I was once in your shoes, learning this stuff on my own.
Even seasoned stock traders can have difficulty with options. Volatility doesn’t affect stock prices and shares never expire.
Options trading is an altogether different animal.
A question that came up last week was about buying long puts.
“How do you determine which expiration date to use when purchasing a put?”
I’ve been at this for so long, engaged in the intricacies of chart analysis, that I forget to discuss the simple things. And while simple, selecting expiration is critical for any trader’s win rate.
Let me start by reminding everyone about theta.
Theta is one of the “options greeks”…a value representing time decay.
Remember that options aren’t shares. They’re time-sensitive.
Each day you hold a long option (call or put), its value decreases. And the value drop increases in speed every day closer to expiration.
At 30 days or less before the contract expires, it really starts to bleed out.
If you’re still holding it on the expiration date, it has zero value aside from what you’d earn if you exercised it to buy or sell shares.
So timing is critical.
Assume you believe that a stock price will drop and want to profit by buying a put.
Okay.
So far, so good…
But you need to determine how quickly you think this drop will happen.
Are we talking about over the next few days, two weeks, or three months from now?
“Next week we honor those who have given the supreme sacrifice to allow the rest of us to live the kind of life we do. For me individually, this is a very tough time of the year. And it is all coming back to me this morning.”
Your expectation of when the stock will fall is the most essential component of which expiration you pick.
Think about it.
If you buy a put on XYZ with only 30 days until expiration, then XYZ needs to go down fast, or you’ll run out of time. If it starts its drop on day 15, the value lost from theta could outrun the value gained by the directional move.
In other words, you could be correct in your prediction and still lose on the trade.
There’s nothing more frustrating than having to exit a trade just before the ticker starts to move.
But that’s just how it goes.
You want to buy yourself enough time to be correct.
The move on the underlying stock must occur well before an option expires. That way, you can make your profit and move on to the next trade.
So here are some basic guidelines.
When trading off the daily chart, pick an option that expires in 21-45 days. For positions based on the weekly chart, 60-90 day expiration options work well. And if you’re trading long term, using the monthly chart, look for 6-12 months until expiration.
Remember that your hold time will be far shorter than the expiration day.
You’ll just take profits at your predefined targets and be on your way.
I agree those are some pretty broad ranges.
Though I can’t really get too deep into it in this short piece, the specific time depends on how quickly you expect the stock to move and how much you’re willing to pay.
There’s always a trade-off.
Nearer expiration options are less expensive because you pay for the time, but ticker XYZ can’t tarry, or you’ll lose. On the other hand, longer-dated expirations can be pricey but give you greater leeway to adjust.
It’s a delicate balance.
Hope this helps answer some of your concerns. As always, I’m here to make you successful.
I’d love to dive in more and coach you one-on-one, so head on over and join our Alphahunters subscribers today! Just this week, we just cashed in on a nice 62% win on BKR.
Cheers,
Chris Hood
