I often preach the virtue of being patient when trading options. It’s one of the basic tenets all options traders live by (or try to). However, you have to balance being patient with managing options time decay.
Now if you’re investing over the long-term in stocks, you don’t have to worry about time decay. You do have to be patient, though. If you can put your capital in a group of stocks and be patient while it grows over time, history is on your side.
Patience versus options time decay
If you’re trading options in the short and medium term, you need to exercise patience while keeping an eye on time decay. Options are always at risk of losing value quickly when you are long calls or puts. In options, it’s called theta decay. As time moves on, it erodes the value of the option – unless the price is moving at a stronger pace.
That may sound confusing if you’re new to options trading. Think of it like a carton of milk with an expiration date. As we move closer to the expiration date and the milk is still sitting in your fridge, it starts to get sour and eventually needs to be thrown out. If you drink it quickly, it you don’t have to worry about the expiration date. It’s the same with options.
I you use technical tools to analyze how a situation may play out, you can take risk accordingly – and properly balance patience and time decay.
Questions to ask before you sell
You can also ask yourself the following questions:
- How much time is left in the life of the option?
- How close to breakeven is it?
- Is the option in the money or near the money?
- What is the probability that the stock will move over the strike price?
- Are there any catalysts to drive the price (like an upcoming earnings report)?
- Is implied volatility high or low?
The answers can help you decide how patient (or not) to be while you wait for your desired outcome – selling the option at a higher price than we bought it. And remember, it’s always good to sell an option when you have a profit. Hold out for more, and you could lose all profits.
