Options Time Decay Or Time Value Of An Option
Apart from the stock price going in the opposite direction(e.g. stock price falling for a call option) what is another thing that can go wrong? The stock doing nothing(not going up or down) or wasting time till your option expiration date. Since options are a wasting asset, if the stock price does nothing till your expiration date or doesn't move faster in the anticipated direction than your option decay, you might lose money.
Options start losing value as early as 120 days before the expiration date. This time value decay speeds up in the last 60 days with the last 30 days being the fastest. This means if you have options with an expiration of 60 days you can expect to continue loosing your option investment value as days pass by even if the stock does nothing.
So what does all this option decay imply?
- If you want to speculate on an earnings event, buy an option just a couple of days before the event e.g. if the earnings report is due July 1 and
if today is June 28, buy the option with an expiration date of July(around 22 July-check yahoo finance). You don't want too much gap between your
earnings event and your option purchase date for your option to lose value for no reason.
Note: If the stock has a Weekly Option, then use that instead to speculate on the Earnings event. Please see the section "Weekly Options" from the left menu for more details.
- If you are going to hold the option in the last 60 days all the way close to expiration, you better be anticipating the stock will make a fast enough move to negate the option time value decay in order for you to make money.
- A stock remaining flat(neither going up or down) will make your options investment lose value over time.
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