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.
Stock shares never expire.
Once you buy them, you own them forever.
Shares fluctuate in value over time and might undergo a split or reverse split. But unless the company goes bankrupt, their shelf life is infinite.
It’s a critical difference between options and stocks.
Options aren’t shares. They’re contracts to buy or sell shares at a specific price on or before a particular date.
That date is known as the expiration.
Back on May 5th, my Alpha Hunters clients bought a long call on C as one of our Lottery Trades with an expiration date of Jun 18th, 2021.
C 100 18 JUN 21 72.5 CALL @3.28
We paid $328.00 for this options contract with the intent to sell it as C rose in price and increased the value of the call.
The plan was a success, and we cashed out on May 20th for a 51% gain.
Not bad for a quick 10-day hold.
I chose this call because my proprietary technical algorithms and 20+ years of trading experience let me know the move up was about to happen.
However, any trade could go wrong, so let’s imagine that C did absolutely nothing.
What if we were stubborn enough to keep the call until today?
At the time we bought it, the expiration was 46 days away. So if we still had it on the books, it would expire in just 22 days.
Not a great situation for us.
Let me explain.
Each option has several Greek values associated with it.
We’re only going to discuss two at the moment – delta and theta.
Delta represents how much the option price is expected to move for each dollar movement in the underlying stock.
Assume our long call on C had a delta of 0.76
If we bought the call when the stock price was $73.00, then a move to $74.00 would cause the value of our option to rise from 3.28 to 4.04.
That’s a $76.00 gain on our contract – precisely what we want.
A long call is a directional bet on the stock going up in price.
Had C dropped in value by the same amount, from $73.00 to $72.00, we would have lost $76.00.
However, we can’t wait too long for the stock to move.
Another value, called theta, represents time decay, or how much value our call option loses each day towards expiration.
Consider this scenario.
If the C call’s theta was -0.98, then, for each day that passed, our position would erode by $0.98. Nearly a dollar per day.
So holding a call for too long works against us.
It’s important to understand that delta and theta are dynamic, theoretical values. Many other factors influence options prices, but these basic ideas are critical.
When we buy a call, it is a race against time.
We need the stock price to rise quickly to protect as little of this time value as possible. This is especially true given that theta increases for each day that passes.
Within 30 days until expiration, it accelerates rapidly.
So how do you use this information when trading?
Decide what you think the stock will do. If you see a slow upward grind over time and prefer to worry less about theta, buy calls at further expiration dates.
A good rule is to have at least 90 days on the clock.
You’ll pay more for the options contract when you go further out, but you buy more time to be right on the stock movement.
If you’re playing for the quick pop or breakout, a nearer expiration might be best.
Be sure to track your delta and theta, or you can get into a situation where you’re bleeding money so fast that even a run on the stock won’t make you any profit.
Options give you a leveraged return.
Your position will have a much higher percentage gain (or loss) than owning the 100 shares it represents.
It’s very different from buy-and-hold stock trading.
Image a stock share as a wrench in your toolbox. It might sit around for months doing nothing, but damn, it’s valuable when something breaks.
And wrenches don’t go away.
Options are somewhat like a gallon of milk in the refrigerator. You better drink it, eat some cereal, or bake a cake right soon.
And keep an eye on the date.
If it sits around too long, it’s so worthless no one will want it.
Our team of Alpha Hunters is putting these ideas to work for them right now and making money every week.
We’d love to have you on board.