by John Lansing 07/31/08
Trading options and making profits is exhilarating -- everybody likes to talk about their winning trades. Those aren't like making the winning touchdown at the Super Bowl, in which the most-disciplined and, let's face it, the luckiest player on the team gets the honor and will probably never have such an honor again for the rest of his career. No, with options, you can make winning play after winning play -- you're the one who can move the odds into your favor, time and again.
Traders are often caught off guard by how quickly options can lose their value thanks to decreasing stock value, as a small move in the underlying shares can translate into an option position that gets wiped out within minutes.
Time decay -- a risk that comes with every option position you establish -- serves to create the second half of a one-two punch that can turn otherwise-solid positions into Swiss cheese.
Time decay is exactly what it sounds like -- the closer an option is to the end of its life cycle, the more quickly it loses its value. Also, the longer a trade stays in the red, the less likely it is to rally back up to breakeven or even into profitability before options expiration rolls around.
Of course, we don't trade options to lose -- we trade them to win … and win big. Trading options as a speculative bet that a stock will go up (or down) gives us an incredible opportunity to double or triple our money. But whether we win or lose is dependent upon how the stock is trading.
