A subscriber recently sent me this question:
Sean, what is your strategy for handling the impact of Theta on an open position? Is there a bailout point where the time decay outweighs the potential upside?
The answer is YES. Theta, as well as Gamma often become my enemy as we near expiration. Here’s how I approach it…
Generally speaking, when the calendar hits the 1st of the month, I review all of my open positions that have options expiring in that month (at this point, usually 2-3 weeks away).
For short premium positions (Naked puts, Iron Condors, short vertical spreads, short strangles/straddles), I look to exit these ASAP. I’m still holding them because they haven’t yet hit my profit target (usually look to cover these for 50% of the credit I received at entry), and now I’m running out of time. As I near expiration, these struggling positions will become more and more sensitive to changes in the underlying thanks to rising gamma. Yes, theta may be working for me, but gamma makes these positions a tough hold. I’m looking to get out, win or lose.
For long premium positions (Long Calls, Long Vertical Spreads, Long Straddles), I want to observe the “moneyness” of these positions.
- When the long options are in-the-money, I’ll look to hold these positions as long as I can, until any short-term support (calls)/resistance (puts) is broken. Yes, theta is accelerating into expiration, but the amount of premium at risk in an in-the-money option decreases as the option goes further and further in-the-money.
- When the long options are out-of-the-money, I’ll look to exit the position ASAP (if there’s any premium to sell into — often there is not) because out-of-the-money options will surely begin to rapidly lose premium and I’ll be swimming upstream against the current even if the underlying moves in my direction.
Are there exceptions to the rules above? Absolutely. Trading is a constant process of adapting and re-evaluating. But generally speaking, this is how I approach my positions as we approach expiration.
I hope this helps you as you think through your processes.
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