How To Use Time Decay To Your Advantage

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To be a successful options trader, you need to learn how to use time decay to your advantage. This is far more complicated than you might think – especially if you are new to options trading.

Many new traders are tantalized by potential high returns when buying calls or puts. As long as the stock moves in the right direction within a certain amount of time, you will enjoy a nice profit.

Time decay can hurt buyers

But buying options has a downside, and that is the aforementioned time. Each option has time decay built into its price, and that means the clock is ticking at all times. When the markets are closed, like on a weekend or a holiday, time decay eats away at option premium. Buyers hate it, but sellers love it.

I hope I have not completely lost you here, so let me back up.

Options trading is a zero sum game with a loser on one side of a trade and a winner on the other side. Options buyers need to time their trades correctly. At the same time, they need price action of the underlying stock/index to move fast enough in the right direction to overcome the decay factor. If they can do this, the option becomes increasingly more valuable.

While stocks historically head higher over the long term, options are volatile over all timeframes, especially in the short term. This is due to relative uncertainty of events, such as news or earnings reports, that can move the name higher and lower in a very wide range.

And it can benefit sellers

Option sellers can take advantage of this wide movement (called high implied volatility) by selling the option premium to the buyer.

If buying options can return large gains, why on earth would you want to be an option seller? Well, options expire worthless about 80% of the time, giving you the chance to profitable four out of five times. (You must be willing to hold the option until expiration, or close out the position at a profit by buying it back at a lower price.)

Hence, selling an option affords you time to let the underlying stock/index move away from the strike, letting time decay work in your favor.

Bottom line, time decay works in your favor as a buyer or seller. When selling options you can create a nice income stream by selling against your stock week after week, month after month.

You can also simply sell puts or calls (not naked!) on a regular basis. Remember, selling is not dependent on a bullish or bearish trend. You can profit when an option moves in either direction.

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