Option trading time decay strategy board
Time decay is your enemy if the stock is below strike B, because it will erode the value of your two long puts more than the value of the short put.
If the stock is at or above strike B, time decay is your friend. You want all of the options to expire worthless so you can capture the small credit received. Time decay is the enemy at stock prices across the board, because it will erode the value of your two long puts more than the value of the short one. After the strategy is established, an increase in implied volatility is almost always good.
Although it will increase the value of the option you sold bad , it will also increase the value of the two options you bought good. Furthermore, an increase in implied volatility suggests the possibility of a wide price swing. The exception to this rule is if you established the strategy for a net credit and the stock price is above strike B.
In that case, you may want volatility to decrease so the entire spread expires worthless and you get to keep the small credit. Options involve risk and are not suitable for all investors. For more information, please review the Characteristics and Risks of Standardized Options brochure before you begin trading options. Options investors may lose the entire amount of their investment in a relatively short period of time. Multiple leg options strategies involve additional risks , and may result in complex tax treatments.
Please consult a tax professional prior to implementing these strategies. Implied volatility represents the consensus of the marketplace as to the future level of stock price volatility or the probability of reaching a specific price point. The Greeks represent the consensus of the marketplace as to how the option will react to changes in certain variables associated with the pricing of an option contract. There is no guarantee that the forecasts of implied volatility or the Greeks will be correct.
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The Strategy This is an interesting and unusual strategy. Options Guy's Tips If you own a volatile stock, this is a potential way to protect your investment against a large downturn with a smaller cash outlay than it would take to purchase a put outright for protection.
Both options have the same expiration month. Break-even at Expiration If established for a net debit, the break-even point is strike A minus the maximum risk strike B minus strike A plus the net debit paid. If established for a net credit, there are two break-even points for this play: Strike A minus the maximum risk strike B minus strike A minus the net credit received Strike B minus the net credit received.
Maximum Potential Profit There is a substantial profit potential if the stock goes to zero. Maximum Potential Loss Risk is limited to strike B minus strike A, minus the net credit received or plus the net debit paid.
Since there are weeks in a year, most cycles have 4-weeks duration. Each of these weeks has its own personality and understanding of the nuances can help a trader select a structure that will benefit from the tendencies of the particular portion of the cycle in which a trade is placed. A classic characteristic of the last week of the option cycle is the ever increasing rate of decay of extrinsic premium.
Jeff Augen has even gone so far as to characterize the breathtaking acceleration of option time decay during this period in his ground breaking book entitled Trading Options at Expiration: Strategies and Models for Winning the Endgame.
For this reason, option structures that benefit from rapid time decay of premium work well in the last week of the monthly cycle. As another example of seasonality within each of the twelve annual monthly cycles, butterflies become exquisitely sensitive to price movement during the last week of their life.
Early in their life, butterflies are gentle creatures blowing gently in the currents of price oscillation. As they age, minimal price fluctuations can have dramatic influences on their valuation as these gentle creatures become infected by gamma and forget their gently accommodative nature. For this reason, many experienced traders advise not allowing short butterflies to survive beyond the Friday before options expiration week. Long butterflies with the short middle strike residing at-the-money greatly benefit in this last week of life.