How Theta Can Make You Rich
When it comes to options selling, understanding, and applying certain risk metrics can go a long way in helping you become successful. Theta is a powerful (and often overlooked) risk metric that could make you rich in the long run. It just requires that you look at the market a little bit differently.
What Is Theta?
In simple terms, theta measures the rate at which an option's value declines due to time. Investors also refer to it as an option's "time decay" because the contract loses value as time moves closer to the maturity date.
Theta is usually expressed as a negative number. You can think of it as the amount by which an option's value will decline every day as it approaches maturity.
How to Make Time Decay Work For You
As you can see, theta represents a challenge for options buyers because it quantifies the risk time poses to their position. After all, you can only exercise your option for a certain period of time.
But if you take the opposite side of the trade-selling options instead of buying them-you can benefit from a "positive theta position." As an options seller your earnings increase as theta accelerates.
In other words, option selling puts time decay to work for you, not against you. With every passing day, all things being equal, the price of the option declines by the theta value, giving you, the seller, a profit on the position.
If you sell options methodically over time, you can collect premiums on relatively low-risk positions. Although your potential ROI on each trade is lower than the buy side, you can benefit from a much less risky position. The business of collecting premiums allows you to essentially "become the house." In this scenario, you are the "insurance company," as option buyers will pay you for insurance.
Some people have described theta as "money for nothing" because it lets you cash in just by letting time pass. Theta makes option selling far more useful than putting money in a savings account, where the forces of inflation and near-zero interest rates decay your purchasing power. A few short trades every week can add up the percentage points over the long term. That could shave years off your expected retirement date.
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