Time is money. While this phrase seems relatively straightforward, using the time to one’s advantage can be more complicated than it appears. For example, would you use an ATM card if the bank charged $3 for every transaction? Likely not. Therefore, by comparison, a bank that charges 10 cents per transaction and offers free withdrawals at all hours of the day and night will be more attractive to most customers. Similarly, in the stock market, timing trades correctly can mean the difference between success and failure —and thus large profits or heavy losses—for investors.
Time is crucial for options traders (especially equity options traders) because expiration dates make up such a large portion of their investment decisions. Though you should consider other factors when trading options, expiration dates are the most difficult to manage.
A “short straddle” is an investment play that involves simultaneously selling both call and put options on the same stock with the same strike price and expiration date to generate immediate income. If you’re thinking, “But how is this possible? Selling things you don’t own seems like it would be illegal!”. You are correct; in fact, options trading platforms disallow shorting actual shares of stock precisely because people might try to do what a short straddle entails. However, when trading options, this is allowed and encouraged by brokers because it generates additional revenue for them.
In a short straddle, a trader would typically aim to sell both a call and put option with the same expiration date and underlying stock with strike prices around the current stock price. Consequently, if the investor expects the price of this stock to remain close to its current level near expiration, then selling a short straddle will lead to maximum profits. In contrast, if an options trader believes that prices will either go up or down significantly in this timeframe, then selling one of these options instead of both is likely more profitable because it gives them greater flexibility in choosing which investment path to take.
An “iron condor” is another popular options trading strategy used for time decay. It requires selling both put and call options on the same underlying stock with the same expiration date but different strike prices—for instance, one option might have a strike price of $50 while another has a strike price of $60.This trade aims to keep all four options open until expiration so that they can be closed together to either generate income or minimize losses.
If you’re wondering why someone would sell both put and call options at the same time; when typically, traders look to buy one of them depending on which investment direction they think shares will take. You are correct in assuming that it’s impossible to win no matter what happens unless there are significant moves in share prices. However, the goal is to close both trades before this happens and minimize losses or keep all options open until expiration to collect a sum of money or because share prices remain within a specific price range.
Another way to time the market is by waiting for price gaps in the underlying stock. A gap occurs when there’s a significant increase or decrease in share prices between one day and the next. It would be great if every gap resulted in an immediate cash windfall for options traders, but that’s not always going to happen since markets aren’t that efficient. However, there are ways an observant trader can use these gaps to their advantage—for instance, buying put options on a stock that is likely to drop in price the next day because of a recent big sell-off.
If this happens, you can open a “down gap” by buying a put with a strike price slightly above the current stock price and an expiration date one or two days in the future. If prices fall the next day as expected, this trade will lead to maximum profits for the options trader. Alternatively, if there’s been a significant increase in share prices over the past few weeks, but you think that it’s about to stop or reverse course shortly. You could also open up an “uptick down” play where you would buy call options with strike prices just below today’s closing stock price.