Last month, we looked at options and covered the basics. Time for some fun. Grab your tinfoil hat and galoshes. We are going on a dark journey. Rarely talked about, in back alleys it’s whispered only in hushed tones…shhh…time decay.
All options have an expiration date. You have the right to exercise your option until that date. Time decay is simply time running out as that date draws near. Want a visual? Imagine a handful of sand. Imagine sand slipping through your fingers as you near the deadline.
If the option expiration is a year away, it will have a lot of time value. If it expires in two days, not so much. Options are priced to fail. Based on the volatility of the stock and the amount of time to expiration, most options whither away worthless much like the handful of sand. What this means to you is, if you buy a call option because you’re sure XYZ stock price is going to soar, that expected bump is already priced into the option.
If you’re still reading, it’s now safe to take off your hats. The bottom line is, it’s really hard to make money buying options. It’s gambling. The stock not only has to move in the direction you think but it has to outpace the time erosion. Even if you’re right, you could still lose. Visual? Think jumping in a river and trying to swim upstream.
If you read between the lines, you know where I’m going with this. If buying options is dangerous, what about selling options? There’s risk in everything. If you never trade options, that could be a good thing. However, if you do, why not let time erosion work in your favor? Think downstream.
I will soon be hosting investment seminars at the Cocoa Beach Library. Check with them for time and date.
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