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Strategies & Market Trends : Options -- Ignore unavailable to you. Want to Upgrade?

To: mtnlady who wrote (7069)	4/30/2000 7:16:00 PM
From: Poet	Read Replies (2) \| Respond to of 8096

Oh gosh, Mtn lady, I was hoping that my delay in responding to your question would have resulted in someone more mathematically-inclined than I answering your question. darn! Here's my answer, but i'd appreciate input/corrections from others (and you know who you are <g>) Your question "Is there a simple "rule of thumb" for calculating the loss in value an option undergoes as the time value erodes?" The Black-Scholes equation is a mathematical formula upon which modern options prices are based. It takes into consideration the following elements: the price of the underlying stock (which in your NTAP example is held constant), the length of time till expiration (which is shorter in your second scenario, which means that the theta decay is higher because there is less time until the expiry of the option), the difference between the strike price and the market price (which you've held constant), the volatility of the stock (a wild card I'll discuss), the prevailing interest rate (which may be diffent in a few months than it is now) and last but not least, supply and demand. The short answer to your question is that selling the Sept 100 puts on NTAP (when NTAP=85) now, versus doing it four or eight weeks from now (also when NTAP=85) is that it's impossible to know! What NTAP itself does over the next number of weeks (Will it rise slowly? Will it be very volatile? Will it crash if there's a market correction?) is an important factor. Essentially, it's best to sell puts on a stock when the stock is at the bottom of it's trading range, and you're bullish on the stock. Since NTAP's made some nice upward moves recently and will soon be facing resistance at 80, I'd be loath to sell puts now. Also, the more volatile the stock is trading, the more inflated the premiums of its options and the better off you are by selling rather than buying those options. This is why I often wait until a "day of fear" when the Naz has a big selloff to sell puts. You get the benefit of a lower price on the stock (so a higher price on the put), along with inflated premiums because of the volatility. Another factor is the prevailing interest rates, which remains unknown. And last but not least, there are a number of different schools of thought about how far out to sell puts. I do best with short term trading so I'll give you my biased opinion: I will only sell front-month puts. The reason is that the theta, or time decay factor, is highest in the options that are due to expire in the month we're currently in (a/k/a the front month). This is what makes buyingfront month calls risky, because the calls decay faster and faster the closer we get to expiration. But this decay works in your favor if you're selling front-month options, ie even if the price of the underlying remains rather constant, the premium of the put erodes faster and faster as we approach expiry. The other factor in this particular market which works in my favor is the volatility. I can sell a May put on NTAP for, say, $14 on a Tuesday when the Naz is dumping, then buy it back that Friday for $8 or $9 if we've had a few strong days on the Naz (and in the underlying stock on which I've sold the put). I can do this two or three times a month, collecting that five or six dollars repeatedly. Anyway, thanks for asking such a great question and I hope my response isn't completely confusing.