Expiration and Option Value
Time left to expiry is an important component in an option’s formula. This value is known as Theta. The further away the expiration date of the contract is, the higher the value of the option is going to be. With a bigger time-lapse, the underlying asset is more likely to have substantial price changes. It stands to reason with as time is passing, an option’s value decreases. This phenomenon is known as Theta Decay. It can occur that you buy an option when Apple is at 100, next day Apple opens at 100, and you end up losing money. You would’ve experienced theta decay first hand. An option’s value decaying over time can be compared to a sand time capsule. In the beginning the top part of the capsule is full, but as time passes, more and more sand falls down. In the end, all of the sand is on the bottom; when options expire, many of them finish worthless.
Let’s recap: options contracts come in two forms, calls and puts. Calls give the option buyer the opportunity, but not the obligation to buy an asset at a fixed price in the future despite the market valuation of this asset. Puts give the owner of the contract the right but not the obligation to sell an asset at a specific date in the future. This future date is better known as the expiration date.
It is for this reason that the expiration date is a significant variable for options traders. The concept of time is an essential factor of what gives the options their value. The longer the time-lapse of the traded option contract is, the higher the chances that the investor has that the asset will reach the strike price. Following this logic, the closer the option contract gets to expiration date, the less valuable the option becomes. As the trend of the stock price gets more predictable, the time value of the contract will reduce accordingly. Once the option reaches expiration date, the time value of the contract will cease to exist.
Given the fact that options that are closer to expiry are cheaper, they are much more lucrative if the price ends up moving in the buyer’s favor in time. The riskiest type of play is purchasing an 0DTE (same day expiry at 4). It is not uncommon to see returns of 100-500%, perhaps even more, on such financial instruments.
Never forgot one of the cardinal rules of investing: high risk, high reward.
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