Taking Advantage of Time Decay

Once a stock or commodity has been wisely chosen as well as the direction you believe it might be headed towards, it will then be the moment for you to choose the strike prices and the expiration date. Given the fact that options are being sold in this strategy the time decay factor will be taken advantage of. Remember that the one big problem that option buyers have and one that works in favor of the sellers, is the idea of time decay. As the buyer of an option, no matter if this is a stock option or a commodity option, time decay is one problem that needs to be confronted every day. Time decay is the feature of options that explains the wearing away of its price, and this makes it lose some of its value every single day that goes by, no matter if the underlying stock or commodity moves or does not move. This can mainly be seen in the at the money ATM, and out of the money OTM options. Whenever an ATM or OTM option is purchased, the person is actually paying for something that does not have any real or intrinsic value to it. This person is actually purchasing something that is completely priced on the value of expectancy and the quantity of time that is left before expiration month. Every day that goes by and where the option remains to not be in the money, the premium is then priced again to a lower quantity. While it has less time to be profitable, the smaller the price of the option will be. This is precisely what time decay is. For instance, let’s suppose at the moment RIP is at $77 per share and that you are bullish, therefore you choose to purchase an $85 call that expires in about three months. What is happening is that you are currently paying some cash today in the form of the option premium in exchange for the possibility that RIP will go over $85 for every share before expiration month. Given that the option does not have any real value yet, at least not intrinsic value, the option premium consists completely on the time factor and optimism. An archetypal price for the $85 OTM call would probably be around $.75. Another example; imagine that your option price began at $.75 and that you have around four months before expiration month. RIP begins to gobbledygook around inside of a price range that is between $75 and $80 and it has a fall down to $72 and a rise of up to $82. Does this option have any value? It does and at the same time it doesn’t. It remains to have a price to it however it is still OTM but without any intrinsic value to it. So imagine now that a couple months have passed by and RIP remains to be at $77 per share. That option could be worth around $.25 at present. Therefore it means you will have lost $.50 in option value simply because of the time that has gone by. RIP remains to be where it was at to begin with; therefore your option is losing its value. There is not so big of a chance anymore that RIP will go over $85 per share now. Even in the case in which RIP went up to $84 per share by the expiration month, the option you have would not be worth anything given that RIP did not go over $85 at any point. In reality, you need RIP to go over $85.75, given that your cost foundation will be such.