Trading is a waiting game, and while the trader waits, their psychology takes over. The decisions that a trader makes after they have initiated a trade can either enhance or diminish the predefined probability of an option. While there is no catch-all trading strategy that predictably works for everyone in the same way, Options Academy offers a unique way to help options traders address this issue.
This simplified approach to option trading divides a trader’s approach into one of three different trading styles labeled with the names of influential variables in the option world: theta, gamma and delta. Each of these styles is focused on a different anticipated win percentage, with a tradeoff of the size of anticipated gains. Although highly experienced traders make use of all three trading styles, beginning traders do well to choose one of the styles that best suits them. Here is a closer examination of Theta style trading.
Theta style trading favors small, consistent winners with an overall high win percentage. This style trades off large profits for consistency. Theta style traders tend to have a personality that gravitates towards positive reinforcement, making it an excellent style for new or inexperienced traders. This style of trading risks losing more than the anticipated size of gains they generate.
What is Theta?
“Theta” is one of the four primary “Greeks” that traders use to describe and analyze various risks to an options trade at any specific point in time. Theta is measured as a value in dollars, and tells us how much an option premium loses (or gains) each day through expiration. For this reason, theta is also known as the time decay of an option. This time decay, or theta, is not linear. Theoretically, the rate of decay will accelerate for the option as expiration approaches.
What does this mean in relation to the Theta style trading?
In options, time decay works against the option buyer, but works in favor of the option seller. This is the crux of Theta style trading. It is a strategy that favors the selling of options – collecting premium and allowing time decay (or theta) to work in Theta style traders’ favor. This is also called being “theta positive.”
Since this trading style uses time as a weapon, Theta style traders typically prefer a trading time frame of one to six weeks (though this can vary). This allows for time decay to chip away at the value of options sold. This also means that theta style traders tend to possess a natural patience.
This style aims for a win rate of 70% to 90%. Since the profits are lower, Theta style traders aim to collect profits more frequently. The tradeoff with such a style is that when losses inevitably come, they are considerable. Remember, this style risks 2 to make 1. Because of this, theta style traders do their best to eliminate mistakes and prefer cautious, consistent profits over big, flashy wins.
There are many ways to sell options. Theta style trading focus on these established strategies:
- Naked Puts
- Bull put spreads
- Bear call spreads
- Iron Condors
- Calendar and Butterfly Spreads
We’ll go further in depth with each of these strategies later. The important thing to focus on is that Theta style traders have a number of ways to utilize time to their advantage.
