How to Take Advantage of Theta Decay in Options

Use the right strategy to profit from an option's time decay.

Use the right strategy to profit from an option's time decay.

Call options give you the right, but not the obligation, to buy an underlying security. Put options give you the right, but not the obligation, to sell the underlying security. All call and put options expire. The closer they get to their expiration date, the more their value declines. This time decay is known as theta. If you buy a call option, theta works against you: Your option trade has only so many days to increase in price and make a profit. If you sell a put option, however, you profit from the option’s decay in value.

Understand what theta is and how it affects your options. Theta measures how much money your option loses per day. Since theta decreases an option's value, it is always a negative number. A theta of -0.50 means your option loses 50 cents each day as long as market conditions remain unchanged. For example, on day one your option is worth $15 and has a theta of -1.50, or $1.50. Subtract $1.50 from $15.00 to get your option’s value of $13.50. On day two, your option will be worth $1.50 less, or $12 ($13.50 minus $1.50).

Sell the put option if you believe the underlying security is in an uptrend. As the security price increases, the put option's price decreases. Theta magnifies the option’s decline in value. Each stock option controls 100 shares. For example, you sell a stock put option for $2,500, which is $25 for one option multiplied by 100 shares. Due to the effects of the underlying security price rising and theta’s time decay, the option is worth $300 at expiration, which is $3 for one option multiplied by 100 shares. You can let the option expire and keep $2,200 as profit ($2,500 minus $300).

Open your trade window in your online options-trading account. All major brokerages require the same information to place a trade. You need to enter the option symbol and the number of options you want to trade. Enter the trade as a sell order. If you want your trade immediately filled, enter it as a market order. If you want it filled at a certain price, enter the trade as a limit order. Place the trade and wait for broker confirmation that it was filled. Monitor your trade. Have an exit strategy in place to take a profit or contain a loss.

Items you will need

  • Online options trading account

Tip

  • If you’re selling a put, select an option with no more than two weeks until expiration.

Warning

  • Trading options can be risky. Only trade with money you can afford to lose.

About the Author

Based in St. Petersburg, Fla., Karen Rogers covers the financial markets for several online publications. She received a bachelor's degree in business administration from the University of South Florida.

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