Invest and Trade Profitably with Jon Johnson

Sometimes in your option plays you choose expirations that are several months out while others not so far. Why do you like to go so far out on some option plays?

August 30, 2000

Over the years, playing options has taught us that the trend and time are your friends, particularly when the market turns choppy as we have seen of late. With options, time is very important because options expire. Thus time works against you on options you buy, and you need time. Time to let the play work, time to let the trend you are playing work. Those two elements can often make you money in a play even when things get choppy.

They say time is money, and with options you pay for time. It is one of the components that makes up the overall price of the option (along with volatility, intrinsic value, etc.). The more time you buy before expiration, the more you pay for the option. Many option players buy same month expirations (e.g., October expirations in October); they are speculating. They have to be right on the movement AND have the timing exactly right or they will lose. When an option gets within 60 days of expiration it starts to lose value based on eroding time value. When it gets within 30 days, time value is bleeding away rapidly, particularly if the option is out of the money. It can be impossible to ever get back your investment unless the stock makes a huge, fast move.

In investing you want to give yourself the edge. You want to stack the deck in your favor. That is why we focus on stocks in solid patterns ready to break higher, split plays with leaders that often race up to the announcement and the actual split, leaders that test the 50 day MVA, etc. as opposed to randomly choosing a stock with a ‘good’ name. Even with that we know that stocks can start a move and then stall a bit, or take a consolidation, then resume the move. With extra time that rest period does not cost us much in lost time value, and we don’t have to be exact to the right minute in entering a play. Thus we are not continually trying to make up lost ground. It acts more like the stock: when it is not moving, the value is not eroding away on us. That helps take out some of the emotion of option investing.

Accordingly, we always look and see how much extra it costs to get another month or two of time. In some instances the time value is low for a month and we would much rather grab that additional time as long as it does not turn the economics of the trade on its head. Typically it is easy to see if that will happen as it either costs a lot more or not. You will see the demarcation point when you look at the various months available.

It is not perfect; if the stock falls, the option value will fall as well and you may not recover even if the stock does. You still have to enforce loss rules. If the pattern breaks down you don’t know when it will recover. If it takes too long, you end up losing more than if you cut your losses and looked for better game.

When selling options (short selling options as opposed to selling options we already own) we put time on our side because the time decay works FOR us along with any price movement in the direction we want. We are selling either the right to buy a stock at a certain price (calls) or the right to put a stock to someone at a certain price (puts). In either situation we are obligated to either produce the stock (if called) or buy the stock (if put). That makes this a riskier strategy, but one that is very powerful because it puts time on your side along with the trend. You have two friends in this situation, stacking the deck in your favor a bit more. We really like selling options and we discuss how we do that in our online seminars in the Options You Can Use Seminar.

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