- Theta decay is a real and persistent feature of options markets.
- Theta decay is often more substantial on lower priced securities, due to higher IV
- On the last 30 days of an option contract, theta decay speeds up
- the important number for determining if taking advantage of theta decay is profitable is
max profit / capital used / days to expiration = expiration daily % gain
- if
expiration daily % gain (ed%g) is greater than the daily % gain required to meet your target returns, the option is worth considering.
- if ed%g is high, theoretically this means that the market is assigning a higher probability to the outcome where your option does not expire worthless, and instead you are assigned.
- Thus the most important thing to mitigate when chasing high ed%g is assignment risk. Mitigate it by:
- using technical analysis to project likely price floors/ceilings and write options outside those lines
- using fundamental security analysis to determine "fair value" of the security, and writing options with a margin of safety around it
- Basically, this is a more careful application of "the Wheel" option selling strategy.
- So, to take advantage of theta decay, find a security which is currently selling substantially below "fair value" and has a high implied volatility (relative to the rest of the market) and sell a cash-secured put on it.
- choose strike price by balancing desire to avoid assignment with ed%g. Usually a little OTM backed by good technical analysis will avoid assignment. If you believe the stock is likely to rise, sell ITM to make higher ed%g and still potentially avoid assignment. Plus by going ITM you increase your chance of being forced to own the security, which you already want to be long...
- alternatively, find a security which you already own, that is selling above "fair value" and write calls on it. lower the call strike price more if you want to increase your chance of getting out of the stock
