The 3Dimensional Trading Breakthrough
Create successful ePaper yourself
Turn your PDF publications into a flip-book with our unique Google optimized e-Paper software.
<strong>The</strong> 3 Dimensional <strong>Trading</strong> <strong>Breakthrough</strong><br />
<strong>The</strong>ta<br />
Imagine paying $365 per year in homeowners insurance! Now imagine if you<br />
didn’t start paying for a full year of insurance, at first, but rather a pro-rated fee for<br />
the remaining 2½ months of the year. Very simply, you can divide $365 into 365<br />
days and that comes out to exactly $1 per day. Now, if you are only paying for 2½<br />
months, your insurance premium would be approximately $75. Each day, you can<br />
figure $1 is being depreciated from the original premium cost.<br />
<strong>The</strong> same concept applies towards option premiums. Once you purchase (buy)<br />
an option, the premium decays as time expires to a varying degree. I don’t want<br />
to beat this subject to death. However, as a trader you must be aware of this<br />
element. This is a nice concept to understand, but it is not entirely essential to our<br />
style of trading. We will buy options no closer than 30 days to option expiration.<br />
In the last 30 days, option premiums decay in a most rapid manner and the “theta”<br />
factor is most evident.<br />
Options are a “Wasting Asset”<br />
I can wrap up everything that I have just written about options in this paragraph.<br />
From the very moment you purchase an option, you have two elements working<br />
against you:<br />
‣ Time Decay (<strong>The</strong>ta)<br />
‣ Market Momentum<br />
To be specific, once the option is purchased, small portions of the premium are<br />
lost (spent) as time progresses towards option expiration. All “time value” of the<br />
option will be worthless at the time of expiration.<br />
If you bought a call option and the market was going down (against your position),<br />
market momentum is further reducing your option value – and rightfully so. If you<br />
bought “insurance” for a certain market price, and the market is moving in the<br />
opposite direction, then the person that is obligating the insurance (by selling the<br />
option) to you has less of a risk.<br />
This is the primary reason why I prefer not to speculate the market buying options.<br />
In my experience, I have never seen an option trader who buys options to speculate<br />
the market and consistently profits. On the other hand, I know several traders<br />
- 40 -
Change language