Time Decay
We touched on Time Decay in the section “Intrinsic Value & Time Value“, and when you read “Selling Call Options” and “Buying Call Options” along with this page, I think you will really start to understand the benefits of trading options, especially selling options, and possibly start developing a strategy.
The major enemy of the option buyer, and one that works in favor of the option seller, is the concept of “Time Decay.” When reading this page and my section “Why Buy and Sell Options”, you will understand why I use “Time Decay” to my advantage in selling options and shy away from buying options. As an options trader, “Time decay” is my greatest tool, so why would I participate in buying options when Time Decay is the buyers biggest enemy?
Time Decay is a characteristic of options that describes the erosion of their value, causing it to lose a little bit of its value day after day after day, regardless of whether the stock price moves at all. If you go back and review the section “What is an option? (Call)” and go to my real estate deal. You will see that my real estate option had both intrinsic value and time value. When Mary tried to buy me out of the contract, I explained, with more than a year left to the option contract, that time had value because of the potential of the value of the house to go up. I said, if there was only a month or two left to the contract the time value would not be so great, the potential for the price of the house to move substantially is less because of less time. When would the price of a house, or a stock, have a better chance to move up more, with a one year contract or a one week contract? Clearly the one year contract! As that contract went from one year to one week, the time value would drop each day, which would make the option worth less. With each passing day, the time value portion of the real estate option, as a stock option, will erode as you get closer to the expiration date. This is Time Decay in action. If you’re a longtime option trader you may be aware of this issue, but many novice and beginner traders don’t understand this concept. And you must!
Also read my section on “The Greeks.” They are delta, gamma, vega, theta and rho. This section is for more advanced traders. Each Greek in an indicator that lets you know your risk exposure to the market before, during, and after you have an option position in place. The two that are most important for everyday traders, and the ones we are going to concentrate on exclusively in “Main Street beats Wall Street” are delta and theta. I am mentioning them in this section because theta is the name for the Time Decay in options. Theta give us the dollar amount of the daily Time Decay for each specific option. The option’s theta is the measurement of the option’s Time Decay. It measure the rate at which an option loses its time value as expiration date gets closer. The theta of an option reflects the amount by which the option’s value will decrease each day.
Human Time Decay, lol
Because of time decay, I guess we can look at options as a depreciating asset. A few years ago while doing some research on depreciating assets, I came across a very interesting, funny story. Below is a post by a young and pretty woman on a popular forum. She was seeking a rich man to marry. The reply from CEO of J.P. Morgan, Jamie Dimon, to the pretty girl is priceless.
Title: What should I do to marry a rich guy?
… I’m going to be honest of what I’m going to say here.
I’m 25 year old. I’m very pretty, have style and good taste. I wish to marry a guy with $500k annual salary or above.
You might say that I’m greedy, but an annual salary of $1M is considered only as middle class in New York.
My requirement is not high. Is there anyone in this forum who has an income of $500k annual salary? Are you all married?
I wanted to ask: what should I do to marry a rich persons like you?
Among those I’ve dated, the richest is $250k annual income, and it seems that this is my upper limit.
If someone is going to move into high cost residential area on the westside of New York City, $250k annual income is not enough.
I’m here humbly to ask a few questions:
1) Where do most rich bachelors hang out? (Please list down the names and addresses of bars, restaurant, gym)
2) Which age group should I target?
3) Why most wives of the riches are only average-looking? I’ve met a few girls who don’t have looks and are not interesting, but they are able to marry rich guys.
4) How do you decide who can be your wife, and who can only be your girlfriend? (my target now is to get married)
Ms. Pretty
A philosophical reply from CEO of J.P. Morgan:
Dear Ms. Pretty,
I have read your post with great interest. Guess there are lots of girls out there who have similar questions like yours. Please allow me to analyse your situation as a professional investor.
My annual income is more than $500k, which meets your requirement, so I hope everyone believes that I’m not wasting time here.
From the standpoint of a business person, it is a bad decision to marry you. The answer is very simple, so let me explain.
Put the details aside, what you’re trying to do is an exchange of “beauty” and “money” : Person A provides beauty, and Person B pays for it, fair and square.
However, there’s a deadly problem here, your beauty will fade, but my money will not be gone without any good reason. The fact is, my income might increase from year to year, but you can’t be prettier year after year.
Hence from the viewpoint of economics, I am an appreciation asset, and you are a depreciation asset. It’s not just normal depreciation, but exponential depreciation. If that is your only asset, your value will be much worse 10 years later.
By the terms we use in Wall Street, every trading has a position, dating with you is also a “trading position”.
If the trade value dropped we will sell it and it is not a good idea to keep it for long term – same goes with the marriage that you wanted. It might be cruel to say this, but in order to make a wiser decision any assets with great depreciation value will be sold or “leased”.
Anyone with over $500k annual income is not a fool; we would only date you, but will not marry you. I would advice that you forget looking for any clues to marry a rich guy. And by the way, you could make yourself to become a rich person with $500k annual income. This has better chance than finding a rich fool.
Hope this reply helps.
signed,
J.P. Morgan CEO