Options Trading: Time

Submitted by Stock Market News on 27 May, 2011 - 16:16

The role of time decay in options trading.

The third factor that options trader need to consider is time. Unlike shares, they have an expiry date that traders are bound to. In options trading, the movement that you are looking for, whether its a rise or fall, must take place by the expiry date. After the expiry date, the option is worthless. So its no just about the movement and fluctuation of price, you also have to think about the time frame.

Options Time Frame

When selecting a time frame you have to strike a balance between the length of time that you need for your strategy to succeed, and the option's premium. When a trader buys an option, the longer the expiry will be, the greater the opportunity for an increase in share price, and the higher the premium. However, the longer the expiry is the more it costs and the more vulnerable you are due to volatility. This can lead to heavy losses.

Fortunately, unlike volatility, the effects if time is predictable. Time works against the options taker and favours the writer. When you buy, the option will eventually lose its value due to the expiry date. The share price must move far enough by the expiry date to cover your loss. The time you give for your strategy and the cost of that time is an important part of your profitability.

Choosing the Expiry Month

Hypothetically, you opt for a 2 month time frame. This minimises the time value that you have to pay. However your time frame is short. Is it enough to achieve the price movement that you expect? The option will lose its value quickly in its last two weeks.

Lets say you opted for 5 months. This of course, will cost more for the extra time put in, but provides much more room than 2 months. Your forecast have more chances of playing out. However, like what was mentioned before, there's also the possibility of bad timing. If the market suddenly changes then you can get hit pretty hard.

With all points that have been covered so far in starting from trading 101, it is pretty clear there are different factors that come into play when you are options trading. Although you can never really make an precise prediction of what the market will be in the next six months, these pointers are still helpful in steering you into the right direction.