When selling options, time decay is your friend

You’ll recall from an earlier post that when we buy options (either calls or puts), we want to buy as much time as possible.  Because the more time we have, the better our odds that something good will happen – as in the underlying stock makes a big move in the direction we want it too, and our option becomes much more valuable.

Put another way, when we buy an option, we don’t want it’s value to decay rapidly.  Time decay is not our friend.

But what if we are selling options?

Let’s get a little bit competitive here.  Trading options is a zero sum game.  That means for every winner there is a loser.  We want to win.

So when we sell an option, someone pays us a premium for the right to buy our shares at a certain price over a certain length of time.  We really prefer that doesn’t happen, and that their option expires worthless, we keep their premium and sell another option all over again.

So typically we try to sell options that have very little time left and have a high decay rate.  I mean, these things are just rotting in front of the buyers eyes.  They lose value quickly straight to the point of $0 and expire worthless.  In other words, we are trying to sell trash options at the highest premium we can get for them.  And there are suckers, I mean buyers, who will buy these.  In this case, time decay is our friend.

So for a seller’s mentality, I reversed the color coding of the chart.  Selling an option with a long time to expiration is now colored in red (bad), but one with a short time horizon and fast decay rate is green (good).

There are some nuances and exceptions to this, but this general rule gives you an idea about time decay and it’s uses.  The point to take away from this is to always be aware of the time decay before you put an option trade on, i.e, know what and why you are picking the specific option.

Use time decay to accomplish your end goal.

Many options traders, particularly those starting out, do not understand the importance of time decay – and so buy in to a suckers low probability bet.

By the way, don’t feel too bad about yourself when you sell short dated, high decay options.  Because in the reverse case, when you are buying options, the other guy, the seller, is trying to do the same thing to you.

And also, there is the case where serious, accomplished traders just need to cover some other option they have for a few days or weeks by buying your trash option, and it is all they need to accomplish their other means to an end.  And they know about time decay and what they are doing.