Options Education: Time Decay
All options are a wasting asset whose time value erodes to zero by expiration. This erosion is known as time decay. Every day of an option’s “life,” it loses value as the time it has to finish in-the-money passes.
That said, let’s turn our attention to the calendar. The stock market will be closed on Monday, September 2 for Labor Day. This means that we have a three-day weekend. So what does this mean to options?
Over the course of the next couple of days, the market makers, or more likely their computer systems, are going to “push the date ahead” in all their products. So in the market makers’ pricing models, today’s date today isn’t August 26, it’s more likely to be August 28.
As we get closer to this weekend, the computer models will move the date to September 3, which is the day the market opens after the holiday. The models do this to price in the decay of the day off for the holiday. That means that they will take virtually all of the decay out of the options ahead of time, so that they aren’t stuck being the buyer of decaying assets over a long weekend.
So how do we profit from this phenomenon? By selling options or option spreads.
When we sell options, we are trying to capture the option decay as we are short a decaying asset.
That being said, if the computer models push the date ahead too far on Friday, I may take advantage of the cheap option prices and be a buyer of some options.