Key characteristics of Time Value & Tricks and how traders can benefit from it

Time has always been a factor in validating results of any Option trade we do. Importance of Time comes into picture for two reasons:

1. Option Premium being positively co-related with Time left for expiry

2. Our profitability depends on Option Premium (Obviously)

While so much of our attention is on the price of the underlying stock or index whose option we are buying, we also need to pay enough attention to the Time as well. With two decades of history in the F&O market, we have come a long way.

Most of us now know that Options, if held for a long time will reduce in value due to passage of time. For us to make money, the impact of price of the Underlying over time will have to compensate for the reduction in Option Premium due to time.

This is most commonly and rightly dealt with by keeping a Time Stop Loss by many of us Option Traders. The passage of time-led reduction in Premium or Time Decay has two key characteristics. These characteristics help us shape our trades even better by making it more dynamic.

#1 Speed of Time Decay: ## Time Decay has always been compared with the Rent that we pay; more the time to expiry, more expensive Option Premium. However, there is a difference. Difference is the speed to Time Decay

Let us understand with an example. If you Rent a House for 12 months. Rent per month is 10,000 and the whole year is 120,000. With Option Premium Time Decay is lower for first few days, then it accelerates as the Expiry Date of the Option Contract comes closer. Time Decay is highest closest to the Day of Expiry.

So, replace Rent with Time Decay. Out of 120,000. 1st Month which is beginning of the 12 months contract will have the least rent and last month will have the most rent.

##How does it impact us?##

To all of us who keep Time Stop Loss for our Buy Option Trades, we can be more generous in keeping Time Stop Loss (SL) in the beginning of the expiry and a little tighter towards the end of the expiry.

One formula that has worked for me is:

Time Stop Loss in Days = No. of Weeks Remaining for Expiry.

4-Days’ Time SL for start of the month and Intra-Day Square off in the Week of Expiry (Since, there are no weeks left for Expiry).

#2 1st Expiry + 2nd Expiry > 2 Expiries:

This is one more thing that one should always keep in mind for the times when we Buy Option keeping the entire Premium as Stop Loss.

Trade Set Up is like this, 100 Call @ 3.5 bought with underlying at 100 and Target in Underlying at 110.

So, if my target comes by expiry, I will make 6.5 (110-100-3.5) justifying the risk of entire premium going to 0 with no stop loss.

Let’s go back to the characteristic and see what it means and how can it help.

For Example,Current Stock Price @ 10030 Days to Expiry 100 Call = 3.5

60 Days to Expiry 100 Call = 4.9

This means that if I am going to be holding on to the Option for 60 days, I am better off buying 60 Days expiry Option then 30 Days expiry Option Twice.

Sounds like a good piece of information, but where do we use it?

Well, if you feel that Nifty Option you are planning to Buy is expected to yield result in 2 weeks, I will straightaway buy the 2nd week option and save on the Option Premium.

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