Options Time Decay

Let’s look at an alternative scenario. The score is 25-21 with 30 seconds left on the clock. The ball on the 10-yard line. Our bet is still fully on and we are on the edge of our seats. Time decay is at its maximum. Each second is prized. Conversely, gamma and the opportunity for our winner to turn to a loser is only a pass away.

There is No Free Lunch 

When we sell volatility, we are betting against the stock moving and we want exposure to theta. When we buy volatility, we are betting on the stock moving and we want exposure to gamma. Neither is a free lunch. Theta and gamma are in a constant battle against each other.

If you have read a little about selling options, it would be tempting to sell these shorter-dated options to maximize your theta decay. Yet In doing so, you are also maximizing your gamma risk. In essence, you are betting on the outcome of the game on the last play.

Time Decay and Systematic Strategies 

Theta decay does not equal Variance Risk Premia. Yet it is true that selling options and being long theta has a slight positive expected value in the long run. There is no systematic strategy for taking advantage of this that is better than another.

Ultimately the shorter-dated options will have a higher variance risk premia as they are more difficult to hedge, have more gamma, and therefore variance. Longer-term options have less gamma, but also less theta. Ultimately for systematic strategies, it comes down to investor preference.

For more active investors willing to hedge frequently and embrace more variance, trading shorter-dated options might be more fruitful. For an investor who doesn’t have time to look at their portfolio frequently or would rather hedge infrequently, rolling longer-dated options would be a better fit.

If you are unsure or new to options, I recommend paper trading both an option expiring in one day and one expiring in one month and watch how their deltas and your P&L change over the course of the day. Alternatively, if you like watching sports, watch how the betting odds swing drastically in the final minutes of a close game vs. a blowout.

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Disclaimer: The information above is for educational purposes only and should not be treated as investment advice. The strategy presented would not be suitable for investors who are ...

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