Time decay. In options we call it theta. Can work for you if you are short options but against you if your long. I realized last night playing baseball with one of my boys that since I am long a 50+ year old right elbow, theta works against it. I have always thought of myself as a pretty good athlete. However this last year or so it seems I am on the increasing part of the theta curve when it comes to certain parts of my body – like my left knee and right elbow. Since I have no interest in selling or getting short my elbow or any other part of my body all I can do is try to manage and live with it. Too bad I can’t just roll out to add more days to expiration. I guess that’s what orthopedic surgeons do.
Expiration week. I remember the days when expiration week happened once a month – not once a week. But since this week we have a serial month expiration I will spend a few minutes going over some of the ins and outs of expiration.
Today is the last day all August non weekly options trade. Once the market closes the value of options settle at their intrinsic value. All out of the money option go to 0 and in the money options to whatever they are worth relative to the underlying and strike price. Cash options like SPX and RUT settle in cash while equities deliver stock. For those that already trade lots of weeklies you know how large gamma and theta can get for at the money options and how quickly they fall off as we move out and in the money. That large gamma can make for some hairy adjustments so don’t wonder too far from your computer if you have positions on.
Finally, if you trade equities you may be familiar with pin risk. This occurs when the stock settles right at a strike price. If you are short options you basically have to guess if the holder of the long option will exercise his option or not. My advice to avoid this is to simply buy back the short option before the close on the last day of trading. No short option – no pin risk. No more problem. As we carry options into expiration week the potential returns get bigger but so do the risks. Like a car traveling at 80, it is harder to make quick adjustments in case of trouble than if you are traveling at 30. But if all goes well you can get to your destination much faster.