Sunday, April 03, 2011

Looking to the Future with Options

As time progresses, options become riskier and riskier to hold.  Good Traders, like good drivers, look as far ahead as possible.  

But what a lot of option traders don’t appreciate is that time decay kind of gums up the works for this calculation. Options lose value by the amount of their theta each day. But theta doesn’t come out of the option price on the closing bell each day. Professional traders have been around the block. They know theta is coming. So they move the day in their models ahead sometime during the trading day (i.e., before the end of the day) to get ahead of the game. In fact, towards the end of the week, they generally start taking time out of their models more aggressively because they need to take out a total of three days of decay to account for the weekend. Often, by the end of the day Friday, they have moved 
their models ahead three full days to reflect Monday’s theoretical prices

So is the secret to winning in the stock market to not look at yesterday's close but to look at the next 3 days of potential opens and what the futures/options markets are doing?

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