The previous lesson introduced Theta decay and its relation to long option positions. This lesson will focus on short option positions that experience positive Theta. Short positions are Theta positive because as time passes it becomes less likely that an option contract will finish ITM. This is positive for an investor who has written a option contract because they want the contract to expire OTM and worthless. Theta is positive for written (short) option positions when the contract is OTM. If the short contract is ITM Theta will be negative because of the likelihood of the option finishing ITM.
An investor has written the Potash December 100 put
option contract that has a premium of $1.15 and a daily Theta value of
.05:
One passing day will reduce the value of the contract to $1.10
(positive for an investor who is short the contract and negative for
an investor who is long the contract)
Investors who write options are said to have "time on their side." Option buyers are always fighting time decay while option sellers benefit from the passing of time.
An option position that is ITM will have minimal time decay which will be mostly offset by the intrinsic value because the odds of expiring ITM are higher.
There are many strategies that investors use to sell option
contracts to take advantage of time decay. Selling OTM options with
short times until expiration can be very profitable over the long run.
These strategies will be discussed in future lessons.
| < Prev | Next > |
|---|