Understanding Option Decay: Key Points and Strategies

By Lawrence G. McMillan

In this article from our archives, we delve into the intricacies of option decay, focusing on the differences in how in-the-money (ITM), at-the-money (ATM), and out-of-the-money (OTM) options lose value over time. Recognizing these decay rates is crucial for traders to make informed decisions and develop effective strategies. Here are the key highlights:

Key Points

Decay Rates:

• OTM Options: Decay faster initially, then slow down as expiration nears.
• ATM Options: Hold value until close to expiration, then decay rapidly.
• ITM Options: Decay steadily over time.

Strategies:

• Selling Options: Better to sell OTM options to capitalize on initial rapid decay.
• Buying Options: Prefer ATM straddles for volatility trading due to better value retention.

Practical Tip:

• Time Decay: Sell OTM options with a longer-term horizon and plan to cover them midway to maximize profits.

For more details and charts, read the full article here: Option Basics: Time Decay