Theta is an options trading Greek that allows traders to calculate time decay and thus determine high-probability options to sell against their stock holdings.
Options traders are typically more focused on buying rather than selling options. That’s a shame, because selling options against a stock you already hold is quite advantageous. You just need to be patient and let the clock run out.
Before we discuss theta, let’s take a deeper dive into time decay. You must understand how it works before you can use theta to your advantage.
A quick primer on time decay in options
Unlike stock, commodities, and other assets, options expire (daily, weekly, monthly, or yearly).
Time decay describes the loss of an option’s value as it moves closer to expiration.
When you hold an option, the clock is ticking at all times. And the ticking accelerates as the option moves closer to maturity.
However, as long as price action of the underlying stock/index moves fast enough in the right direction, it will overcome the decay factor and the option will become increasingly more valuable.
For the trade to work, you must be willing to hold the option until expiration and let the underlying stock/index move away from the strike. This is how time decay works in your favor.
How to use theta to your advantage
Theta is key to finding an option that will gain value as it moves closer to expiration.
It is an options Greek that mathematically determines how much an option’s value will erode as time goes by. This is why theta is good for sellers but not for buyers. The value decreases for buyer as the clock ticks away, but it increases for the seller.
When considering selling options against your holding, pay attention to at the money options. They have the highest theta, are more likely to deliver a bigger payoff, and have lower volatility, which usually helps increase the speed of time decay.
Theta can actually help you create income on a stock you own. You’re not selling the option to buy the stock. You’re selling time and letting the clock run out on an option. Because 80% of options expire worthless, you don’t owe anyone money. Instead, you make money as the option increases in value. You have the upper hand and will win more often than not.
With probabilities on your side, selling options is a lower risk way to earn income via options trading. You just need a solid strategy and good old-fashioned patience.
