How to Buy Options With Less Decay (3 Ways)

what's going on youtube chris here with project option in today's video we are going to be talking about how to buy options with less decay and i'm going to discuss three methods with which you can purchase options and minimize the decay that you would otherwise experience if you're new to the channel and you're interested in options trading content with no then please go ahead and give this video a like and hit the subscribe button so that you can get my options trading videos in the future when you buy options time is working against you because options are decaying assets but there are a few ways and in this video we will talk about three ways with which you can minimize the decay associated with buying options meaning there are ways that you can mitigate the extrinsic value losses that will naturally occur when you buy options so let's get started method number one that you can use to minimize the decay associated with buying options and losing that extrinsic value that we just discussed is to buy an in the money option now this means to buy an option with intrinsic value meaning for a call option you are buying an option with a strike price below the stock price and for put options buying an in the money put option means that you are buying a put option with a strike price above the current stock price when you buy an in the money option the option will have intrinsic value and less of extrinsic value so if we take a look at a strip of options and we look at the call options we will notice that the further in the money we go meaning the lower the strike price of the call option we will notice that the option has less and less extrinsic value the further in the money that we go if we take a look at this image of facebook options from today we can verify what i just said if we look at the facebook call option with a strike price of 250 we will notice that this option price is currently around 11.80 and since facebook stock price is actually slightly below the strike price of 250 we know that this 250 call option has no intrinsic value whatsoever meaning that any price or value that it has is 100 extrinsic now if we look at the call option with a strike price of 225 dollars we will notice that this 225 call option in facebook is worth around 29 but if we look at the ext column meaning the extrinsic value in this options price we will see that this option has extrinsic value around four dollars which is only a small portion of the overall 29 option price that we are observing in this moment if we compare these two trades we'll notice that if i purchase the 250 call option for eleven dollars and eighty cents meaning i actually pay one thousand one hundred and eighty dollars and at expiration the stock price is still slightly below the strike price of 250 then this call option will actually expire worthless and i will lose 1 180 on this trade but if instead i purchased the 225 call option and facebook was right where it was right now since that 225 call option has 400 dollars of extrinsic value meaning 400 of the 2900 option value is extrinsic then i would only lose 400 by holding the 225 call as opposed to holding the 250 call and that's because the 225 call is mostly intrinsic value and only has four dollars of extrinsic value in its price and lastly if we look at the 200 call option we can see that the price of that option is around 51.25 and of that 51.25 option only 1.43 cents is extrinsic value so as we look at further and further in the money options we will notice that in general the option will have more intrinsic value and less extrinsic value so the further in the money an option is the less extrinsic value it will have and because of that if you purchase a deep in the money option you will be paying for mostly intrinsic value which does not decay as time passes but you will be paying a very small portion of extrinsic value which does decay as time passes method number two for minimizing the extrinsic value decay when purchasing options is actually a little bit more unique and this is to purchase options when a company has an upcoming earnings announcement when a company has an upcoming earnings announcement or any announcement that there's a lot of uncertainty around the option prices in the short term meaning that if you look at the very short term options that include that uncertain announcement or whatever announcement it may be then those options are going to price in a potential large movement in the stock price and the options will still include that pricing or expectation until the announcement has been made and the uncertainty is no more so as an example if a company is reporting earnings on thursday after the market close and today is monday i could purchase options in this week's expiration cycle meaning that the options expire on friday and i could basically hold these options through thursday and i would have to close them before the closing bill on thursday and by doing that i would own options but since the options are going to continue to price in this big expected price movement in the stock then the options are not going to decay as normal and because of that i have an opportunity for a very limited amount of time to own these options and not experience the same amount of extrinsic value decay that i would if this announcement was not taking place this week so the key here is just to make sure you close these positions before the earnings announcement otherwise you're turning it into an earnings trade and you are fully exposed to the stock price movement after the earnings announcement has been made but also the subsequent collapse and extrinsic value that will happen after the company announces earnings all right let's move on to the third and final method that you can use to minimize the extrinsic value decay that is typically experienced when you buy options so this method is perhaps the most straightforward and the most flexible and it is to buy a spread as opposed to buying naked options so instead of buying a call all by itself you buy a call spread and you structure it in a very specific way so buying a call spread would consist of buying a call option at one strike price and then shorting another call option at a higher strike price so you actually own one option and you're short another option so the decay of the short option actually offsets the decay of the option that you own and if you structure it a certain way which i'll get into in just a moment then you can have a position that has no exposure to time decay meaning that you will not lose money as the options lose their extrinsic value as time passes but you can also structure a call spread or a put spread to have positive exposure to the extrinsic value decay which i will discuss right now the first way to structure a debit spread to minimize extrinsic value decay is to purchase an in the money option and short and out of the money option this way you are buying an option that is mostly intrinsic value and it has very little extrinsic value and the option you are shorting is purely extrinsic value which means as time passes the extrinsic value decay of the option that you are short will only be beneficial to you and the option that you own has very little extrinsic value meaning that you won't be losing much from that option decaying as time passes so let's go ahead and take a look at an image of a call spread that i just set up with this exact structure if we look at this called debit spread on facebook you'll notice that i use the 240 call as the option being purchased and the 260 call as the option being shorted the facebook stock price is right in the middle of these strike prices at two hundred and fifty dollars the spread in this case is trading for ten dollars and thirty five cents giving the spread a break even price of 250 35 and i got that by adding the spread price of 10.35 to the long call strike price of 240. at 250.35 the call spread will have ten dollars and 35 cents of intrinsic value at expiration because the 240 call will have 10.35 cents of intrinsic value and the 260 call will expire worthless therefore the overall spread price at expiration will be 10.35 and since that's the same price we are looking at here there would be no profit or loss on this trade at expiration if facebook were to close right at 250 35 but if facebook stayed right at its current price of 249.76 through expiration then the spread we are looking at would be worth 9.76 because the 240 call would have 9.76 of intrinsic value and the short 260 call would be worthless this would leave us with a spread that is worth 9.76 so if i buy this call spread for its current price of 10.35 and facebook does not change through the expiration date of this call spread based on the current price of facebook shares this spread would be worth 9.76 and if i buy a spread for 10.35 cents and it falls to 9.76 that is a very very minor loss and barely any loss on that spread whatsoever and that would be caused by the extrinsic value decay of course the stock price is going to move between now and expiration but it illustrates that if we structure a debit spread this way meaning that we are buying it in the money option and we are shorting an out of the money option and more specifically if the stock price is basically right in between those two strike prices then you will have a call or put debit spread that will have very little exposure to the extrinsic value decay that will happen as time passes now the second way to structure a debit spread will actually give you positive exposure to time decay or extrinsic value decay and what i mean by that is if you structure a debit spread in the way that i'm about to describe you will have a position that will make money as time passes and assuming the stock price does not change or even moves in favor of your spread so let's look into it now in this image i've used the same spread as before but i moved the short strike to 250 from 260. so this call spread setup is purchasing an in the money option which is the 240 call and shorting and at the money option which is the 250 call the price of this spread is five dollars and 80 cents and the stock price is currently at 249.29 now at expiration if facebook is right at its current price of 249.29 the 240 call will be worth 9.29 and the 250 call will expire worthless now this will leave us with a spread value at expiration of 9.29 if i buy this spread right now for five dollars and 80 cents and at expiration the spread price is 9.29 but the stock price did not move then that means as time passed and as we got closer and closer to the spreads expiration date the spread price was actually increasing in value and that's caused by the loss of extrinsic value in the options in this particular call spread so because the current stock price is actually well above the break-even price then by purchasing this spread i can actually put myself in a situation where i make money from the passage of time as we've learned in this video there are a number of ways that we can implement option buying strategies while mitigating the negative effects of extrinsic value decay as time passes now each of these approaches that we discussed have benefits and downsides in their own regards but the key here is that by focusing on extrinsic value and working with the structure of our strategies and even the timing of our strategies we can strategically minimize the negative effects of losing the extrinsic value in our option purchases as time passes if you enjoyed this video and found it informative i would really appreciate if you hit that like button down below and if you hit the subscribe button and enable notifications so that you don't miss my future options trading videos i'll see you next time [Music] you

Channel: projectfinance

Views: 60,399

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Keywords: how to buy options, buy options less decay, extrinsic value decay, time decay, theta decay, option decay, projectoption, options trading, options trading tips, options trading tutorial, finance, stock options, options trading strategies, buying options before earnings, earnings trades options

Id: ZovGRem2qZ8

Length: 13min 40sec (820 seconds)

Published: Wed Aug 05 2020