For many market traders, looking for a trend or some other market anomaly in order to consistently make money is the financial holy grail. Though there are a number of market systems that claim to be consistent enough to make you money, the reality is that most strategies aren't as trustworthy as they could be, which can cause you to lose your hard earned capital.



A widely touted stock option trading strategy out there in common use today is the idea of "theta decay." At first glance, the name isn't indicative of something positive, but in reality, the concept capitalizes on a well known fact about option trading - options expire on a set date.

Because option trading instruments have a finite life span, their value would tend to change as they come closer to the strike date. In analyzing trends in trading of options, the spread of prices that exist between the issuance date and the strike date is shown to get smaller as the issue nears expiration.

Theta decay analysis is able to serve as the basis for an option trading system because, compared with stocks, options are much more information-rich. The existence of an expiration date gives options traders the information foothold they need. Big gains can result for those able to keep up with the brisk flow of options information.

Actually, it's not that difficult to use theta decay techniques to cash in on those gains. Remember the fundamental concept: the closer the expiration date is, the faster the time value changes. In particular, studies show that the time value of an option decreases according to a linear trend until approximately the last thirty trading days prior to expiry.

During that final month of trading days, theta decay techniques come into their own. It is during that time period when the time values start to drop even more precipitously. By holding the right positions, however, you stand to make money on that fall.

For example, you could hold a short position in an option approaching expiration while simultaneously selling an inverse call option. This benefits you in two ways. First, you reap a benefit if you sell the call at a premium compared to the actual value. Second, you can also realize a gain on the short position, assuming that the option does not finish in the money on the positive side.

As you can see, by tracking expiration dates and perfecting your timing, you can make theta decay a profitable technique. It is true, as with any system, that improper application of the strategy could lose you principal. But for those who have a good feel for the market and the ability to track option market information, theta decay remains a potentially lucrative and non-commonplace device worthy of being added to your market toolkit.