Author: Chris Hood
No matter how you trade options, be ready to do a bit of math.
I’m not talking about college calculus here.
Simple addition, subtraction, multiplication, and a reasonable understanding of probability will be enough.
There are some quants out there who really get into the options Greeks.
I’m not one of those people.
For my style, delta, theta, and to some extent, vega, are the only ones I bother with. And mostly just the first two.
Theta is critical to me because I’m an income trader.
My strategy is to use a statistical edge so that I can meet my daily, weekly, and monthly profit goals. The only way to be consistent with this is to take advantage of time decay.
For regular income trading, always keep time on your side.
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Focus on options selling rather than buying.
When you buy positions such as long calls, long puts, or debit spreads, the stock must move for you to make money.
Not only that, it needs to make quite a bit for you to get past the breakeven point so you can start getting paid.
Let’s assume stock XYZ is trading at 100.00 per share.
I think it’s going to move up in price so I purchase a 0.60 delta in-the-money call that expires in 35 days. I pay $4.50 (or $450.00) for the call.
In theory, for every dollar the stock moves up, my call gains $60.00 in value.
However, because I had to pay for the call, I don’t actually make a profit until XYZ passes my breakeven point of $104.50.
And for every day closer to expiration, my call loses value because of time decay.
There’s only one way to win.
I need to be correct on the direction…and the timing of the move.
If it runs I stand to make plenty, but I don’t get much of a statistical edge on these types of trades.
If I’m an options seller I stand to make less money on each trade, but my probability of profit is much higher.
With trades like credit spreads, iron condors, and short puts or calls, I get paid upfront.
Also, when I place the trade, I can decide my probability of success at the outset. If I set my short strikes far out of the money then I’ll take on a bit more risk, but I’m very likely to win.
Combine this with a robust set of indicators and it can be like money in the bank.
For example, if I trade bull put credit spread on ticker ABC because I’m bullish, I will make money if the stock goes up. My credit spread will lose value and will expire worthless or I can buy it back for an established percentage of the total profit.
But I have two other ways to win.
If the stock doesn’t move in the predicted direction I could still win the trade.
Should ABC go nowhere or even become slightly bearish, I have theta on my side. As long as the stock chops and dips above my short strike, time decay works to my advantage.
Positive theta means time works for you.
Income traders should make sure they go into the close with this in mind.
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