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To: Chuzzlewit who wrote (72755)	10/17/1998 9:20:00 PM
From: JRI	Read Replies (1) \| Respond to of 176387

OT- Chuzz, thanks a lot for all detail you put into your posts during your hypotheticals...You really go all out....I'm sure many others feel the same way...I have learned a lot....Great effort!

To: Chuzzlewit who wrote (72755)	10/19/1998 6:20:00 PM
From: Geoff Nunn	Read Replies (1) \| Respond to of 176387

Chuz, let's pursue the question of the relationship between the time value of a call option and its length of time to expiry. As you have pointed out, generally speaking the loss of time value per day increases as the option approaches expiry. This means that a two month option will lose most of its time value during the second month. So the relationship is non-linear. Let's examine why that is. It's easy to establish that the total value of two successive one-month call options is greater than the value of a single two month option. I'm assuming the strike price is the same for all three options, and equals the market price of the stock. The two one-month options are more valuable because, whatever happens to the price of the stock, they can't do worse than the two-month option and will most likely do better. Suppose, for example, each option has a strike price of $60 and the stock is trading at $60. Let's assume the stock is also trading at $60 at the end of the two months. The two-month option will expire worthless. Yet the two one-month options will very likely yield a positive return. Suppose, for example, the stock trades at $55 at the end of the first month. The first one-month option at expiry will be worth $5, and the total profit at the end of two months will be $5. If the stock trades at $45 after one month, the two-option strategy will also yield a $5 return. The first option would expire worthless, but the second will be worth $5 since its strike price gets reset to $45. It is this ability to reset the strike price after the price of the stock has fallen, when you're holding successive short term options, that chiefly explains the non-linearity in the time-value relationship. When you hold a longer term option, you're disadvantaged because you're locked into the original strike price following a drop in the price of the stock. Therefore, I'm not sure there is any special advantage in writing short term options. Sure, the time premia per day on short term options is greater, but the time value per day is also greater. If you are suggesting short term options yield a higher expected return to the writer, I think that's something that can only be established empirically. I don't see how it can be established deductively, which is what you seem to be seeking to do. What I'm arguing is that the shorter the term of the option you write, the greater the time value per day you are awarding to the buyer. Therefore, if you write these options you can expect to incur greater costs in terms of the losses you will suffer during periods when the stock does well. I don't claim this principle holds for options that are deep in the money or out of the money, which are situations requiring further analysis. Geoff