Over time, a decline of only 10 percent in the stock yields high
percentage returns. This is due to the leveraged directional nature of this
trade—delta.
While the other greeks are not of primary concern, they must be
monitored. At the onset, the 0.80 premium is all time value and, therefore
subject to the influences of time decay and volatility. This is where trading
greeks comes into play.
Conventional trading wisdom says, “Cut your losses early, and let your
profits run.” When trading a stock, that advice is intellectually easy to
understand, although psychologically difficult to follow. Buyers of options,
especially ATM options, must follow this advice from the standpoint of
theta. Options are decaying assets. The time premium will be zero at
expiration. ATMs decay at an increasing nonlinear rate. Exiting a long
position before getting too close to expiration can cut losses caused by an
increasing theta. When to cut those losses, however, will differ from trade
to trade, situation to situation, and person to person.
When buying options, accepting some loss of premium due to time decay
should be part of the trader’s plan. It comes with the territory. In this
example, Mick is willing to accept about three weeks of erosion. Mick
needs to think about what his put will be worth, not just if the underlying
rises or falls but also if it doesn’t move at all. At the time the position is