Option Time Decay

Because of one-series trading nature of options in our market time decay becomes a very crucial factor.Normally when you buy a stock you can give it time to perform what you expect from it.In the case of options once you take a position you will not want it to move in opposite direction.The reason is that you can not hold this option like a stock.There is an expiry date and in the run up to that date options lose value.Each day options lose value because they keep getting closer to the expiry which means that if you happen to initiate a trade and it goes wrong you might face a time crunch where your option will have no time to come to the right side and give profit.However this time decay can be used for good too.Time decay gives good returns if one is short on an option.See it like this,nifty is at 5300 and you write 5400 call with only 10 days to expiry.In the present market it is least likely that nifty will touch it.So you happen to pocket the premium on the trade.As expiry comes and if nifty is not holding up good that will decrease the price of this call option.Now when there is a sizeable market you can exit.In case nifty does make an upmove just hold on to your position.Because these options are cash settled there is no worry of exercise.But make sure that you have written deep out of money strike.If you write an in the money strike you will be held in the court for committing suicide.Anyways,when you write a deep out money call option in this kind of market it will take a very very strong move by the nifty to get that stike in the money.So here each negative move is in your favor and each passing day will also give value to your profits becuase time decay will decrease value of that option.
Suppose you took position in the same strike as above but this time you are long on call.Now you want nifty to move up.What works against you is any negative move of nifty and time factor.As days go by there will be a lesser chance for the strike to become in the money.And ultimately you will lose value if nifty doesn’t perform like the greatest bull market ever.There are two ways to tackle time decay.One,you ignore it.Second,you follow it.You ignore it when you go long on any option be it call or put.And you follow it when you go short on options.Here it is interesting to notice that time decay works on both call and put options.Normally what causes calls to lose value gives a boost to put value and vice versa.In case of time decay it cuts value from both of them at the same time.Only difference is the outlook of the market.Calls and puts both will lose value based on time decay and what the overall market perception is like.Because at one time market can favor either call or put.So whichever is favored will lose lesser than the other one.Using time decay is simple to read but difficult to execute.It will take in issues like margin and good relations with your broker.Your broker must be someone who is ready to help you.There are some rules on shorting a security regarding margin and other such protective measures and these can only be followed if you have a good broker backing you up.
Another observation I have made is in the beginning of a month its running series will do good and not much of time decay will be seen.In this kind of situation shorting can be dangerous.Rather wait for the last week to start.In the last four days there is no buying pressure or at-least very less buying taking place.This is the perfect time to initiate a short position.Collect your money to provide for margin and short the options.You will see that as the focus of trading shifts from running month series to next series there will be only decreasing moves in running options.They are close to expiry and now people are liquidating them.So no fresh buying.This will give you ample returns.In case trade goes wrong.Stay on as long as you can.The chances of odds coming back to your favour are high.
Options depend on their underlyings,this is where they gain value from.Sometimes when market is moving in one direction be it up or down its easy to trade options.Trading options in choppy market is most difficult because there is no direction in underlyings and hence no view on future levels.This kills options faster than anything else.Common known facts say that a market trends only 30% of the time,rest is a choppy market condition.In sideways moving market trading for the time decay is very useful.Very oftne you will see that index starts with gap up or down then moves back in and takes some small swings both ways and finally closes with almost or very small change from previous closing.This kind of day will not give any boost to premiums.Both calls and puts will lose value.Here if one goes short on an option then one has atleast got one factor on his side.He will be gaining from time decay.If market doesn’t become a trending one overnight and keeps on moving sideways there will be a good chance that this short will be exited with a profit.