Trading and investing gurus swear that buying options will make you rich. They tell you of the unlimited earnings potential. What they don’t tell you is that you are likely going to lose far more trades than you win. They don’t want you to know that your biggest winners will likely only cover all of the losses you have incurred.
80% Of Options Expire Worthless
The truth is- over 80% of options expire worthless at expiration. No matter how good your options trading strategy is, you have a 20% chance of winning if you hold it until expiration.
I know what you’re thinking- “just sell the option before it expires worthless”.
Sure, you could do that. You could sell the option as soon as it becomes profitable so you minimize the risk of it expiring worthless. But if you’re doing that, you are giving away your glorious unlimited profit potential.
Time Is Not On Your Side
Let’s forget about sacrificing our unlimited profit potential for a moment. You have to remember that every day it takes for you to be right about the direction of the trade, the further you need the underlying to move for you to be profitable.
Theta-decay, or time-decay, is going to eat away at your option premium every day that you hold it. How about we stop fighting against time and let it work in our favor?
Introducing Theta Strategies
The only way to beat the clock with options is to put time on your side. With time on your side, you will generate more profit as time passes. You do this by using theta strategies.
In order to let theta work for you, you need to collect the option premium instead of paying for it. You need to become an option writer. Option writing is just a fancy way of saying “option selling” or “option shorting”.
When you sell an option for a theta strategy, the entire premium is your profit when it expires.
Selling Options
Selling an option basically reverses everything you know about buying options. Let’s take a look at the basics for option selling to be successful:
Calls And Puts Are Reversed
Reversed?
Since you are selling an option, you are on the opposite side of the contract. Remember- when you buy an option, you are buying the right to buy or sell shares at a certain price. Since you are selling the option, you are the one who is giving the buyer the right to buy or sell shares.
This is a very important concept to understand. You can end up on the wrong side of a trade if you get this confused.
Selling A Call
When you sell a call, you are giving the buyer the right to buy 100 shares (per contract) at a certain price. This means that if the option goes in-the-money, they can exercise it and you will be responsible for selling them 100 shares to own at the strike price.
Guess what- you either need to already own 100 shares of the underlying to give away, or you will end up being short the underlying with 100 shares.
Another important thing to note is this: even if the option expires in-the-money, you still get to keep the premium from opening the short option position.
To simplify the message here: you sell a call when you have a bearish outlook on the underlying. You sell a call at a strike that you believe the underlying will be under at expiration.
Selling A Put
When you sell a put, you are giving the buyer the right to sell 100 shares (per contract) at a certain price. This means that if the option goes in-the-money, they can exercise it and you will be responsible for purchasing 100 shares from them at the strike price.
Guess what- you will be long 100 shares of the underlying.
Another important thing to note is this: even if the option expires in-the-money, you still get to keep the premium from opening the short option position.
To simplify the message here: you sell a put when you have a bullish outlook on the underlying. You sell a put at a strike that you believe the underlying will be above at expiration.
Pick A Strike You Think The Stock Will Not Be Able To Achieve
The process of picking a strike for option selling is different than picking a strike for option buying.
I know, we covered this above already, but it is very important.
When you are selling a call, you need to pick a strike that you believe the stock will be below at expiration.
When you are selling a put, you need to pick a strike that you believe the stock will be above at expiration.
Simply put- you’re picking a strike that you expect to expire out-of-the-money. You reach 100% profit when the option expires worthless.
Pick A Contract That Has A Decent Amount Of Time Value
Since theta strategies thrive off of the extrinsic value of options, you need to pick a contract that has a decent amount of time value. This usually means you’re looking to sell options that are at least one week away from expiration.
The best options to sell are 45 days away from expiration. Thanks to the rate of change in theta decay as an option gets closer to expiration, theta decay happens more rapidly from 45 days until expiration.
Options with a lot of time value left will allow you to collect way more premium.
Longer dated expirations work the same way for you as traditional option buying. You give yourself more time to be right.
Selling Options Offers Flexibility
Going long on options is either a hit or a miss. You’re either 100% right or you’re 100% wrong. If your option expires out-of-the-money, you have realized a 100% loss on the investment.
Realizing a 100% loss while shorting options is rare. In fact, many options sellers rarely ever experience a realized loss.
Selling options offers a level of flexibility that is not offered by any other method of trading. Again, this flexibility comes from time being on your side.
Make Adjustments To Your Trade
The beauty of theta strategies is that you can make a ton of adjustments to your trades to escape realizing losses. There are tons of ways to adjust your positions depending on what theta strategy you are using.
Since we have only gone over simple call and put selling, we will talk about the most common adjustments for the two.
Roll A Losing Short Option
If your short option is in-the-money on the day of expiration, you are not doomed. You do not have to sit around and wait for the buyer to exercise the contract. Nor do you have to close the position out entirely and realize the loss.
Create a rolling order for a further out expiration. Doing this allows you to extend the time of your trade, giving you more time for your option to come out-of-the-money. What makes doing this even better is that you collect more premium due to increasing the time value.
Wow! What other strategy lets you capitalize on losing positions?
Use The Wheel Strategy
The wheel strategy gets its name because this will turn your trade into an endless cycle of selling puts and calls. There are many components of the wheel strategy to make sure it is executed properly, so make sure to check out this post on how to use the wheel strategy to never accept a loss.
Traders who use the wheel strategy typically start out by selling puts. If their options are in-the-money at expiration, they will accept assignment of 100 shares.
Once they have 100 shares, they sell calls to collect premium until the underlying goes back up. If their call expires in the money, they sell the 100 shares from the previous assignment.
I bet you can figure out what they do next….. yup! They go right back to selling puts.
Just Sell Options And Win Over 80% Of Your Options Trades
Personally, I find theta strategies to be very safe and reliable. All you need to do is manage and adjust your positions accordingly and you will rarely lose a trade. Over 80% of options expire out-of-the-money. Theta strategies put you on the probable side of the trade.
Go ahead and combine theta strategies with simple support and resistance trading too further increase your chances of success.
Who loses with over an 80% chance of winning?
Did you enjoy reading this post? What interesting points did you learn? What theta strategies do you use?