Options Decay Over Time

 2/14/2014

In this trading day before the holiday weekend I would like to remind everyone of something I am sure you already know: Options are a wasting asset. They decay over time.

This time decay happens whether the market is open or not. 24/7, every day. This can be especially pronounced over a three day weekend such as this one upcoming.

It also makes perfect sense when you think about it. Time adds value to options. Think of a put as an insurance policy against a decline in the price of your stock. Any insurance policy will cost more if you are insured against a longer period of time. A fire insurance policy on your home will cost more if you are insuring for a whole year as opposed to a week, right? The same holds true with options.

This means that if you own options as time goes on you are going to need a bigger move to make money. Let's say a stock is at 90 and you think it will go past 100 and you buy the 100 call. So you expect the stock to rise more than 10%. Well, with 3 months to go there is a better chance of a 10% move happening during that time as opposed to 3 days to go

The most frequent complaint I hear from novice traders is along the lines of "I thought the stock would go higher, I bought calls, the stock did go higher and I still lost money. How did that happen?"

What happened was only one dimension was considered, direction. When trading options one must always consider three dimensions: Direction (the what) Time (the when) and Velocity (how fast).

Teaching options trading three dimensionally is a core part of my curriculum. If you have any questions about how to learn more about three dimensional options trading please do not hesitate to contact me.

Have a great President's Day weekend!

Randall Liss, The Liss Report