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What to Do With Options Before Time Runs Out


As it gets closer to the new year, time decay weighs heavier on options' value.

Tick Tock

As the markets remain mired in an ever-narrowing trading range, the sound you hear is not only the clock ticking toward the end of the year but also the dripping of option premium as time decay weighs on options' value.

Even as a host of individual stocks from Deere (DE) to the broad indices such as the S&P 500 Index (SPX) are hitting new 52-week highs, the velocity of the move higher has barely offset the time decay of owning options.

For example, one month ago, Deere was trading around $52.50. You could have bought the January $55 calls for around $1.70 a contract. Today, with the stock nipping a new 52-week high of $56.80, those calls are trading around $2.00 a contract. A profit to be sure, but $0.30 on a $4.30 price move can be frustrating.

Granted, there are several tech stocks, like Salesforce (CRM), that have had sharp, swift moves higher of late. But up until today even Google (GOOG), which is finally bursting through the $600 battle line, wasn't a winner for call owners over the past month -- even as the stock trended up some $30 over the prior month.

Certainly those owning Spyder Trust (SPY) options have to be somewhat stymied as the ETF has essentially traded in a 43, or 2.2% range, over the past 30 days. Between time decay and the decline in implied volatility, which has dropped from 20% to 16.5% over the past 30 days, it has conspired to suck the value out of its options. On November 25, the day before Thanksgiving, when the SPY was trading $111.40, the January $112 call was worth $2.50. Today, with the SPY $0.50 higher, those calls are worth $0.65 less.

Look Ahead on the Calendar

But one of the nice things about the Spyder Trust is it offers one last chance to take advantage of this holiday trade time decay. The Spyders are among a handful of index-based products that offer quarterly options. As implied, these options expire on the last day of each quarter, so the current December Quarterlies will expire next Thursday, December 31.

A strategy I've been employing and have mentioned in the OptionSmith newsletter has been to sell these quarterly options to help finance the purchase of January options. For example, one can currently sell the December $112 straddle, that is sell both the puts and calls, for a $1.80 total net credit. One can then purchase the January for $3.60 total net debit. That creates both a bullish and bearish calendar spread for $1.80 total debit.

The thinking is that the S&P 500 will remain bound in the 1110 to 1120 until the end of the year but then once the new year begins the combination of fresh asset allocation and earnings reports will help set up a strong directional move out of the recent range.

So, in the example above, the best case scenario would be for the SPY to be right at $112 next week, which would leave the December options worthless, meaning you're now outright long the January straddle for no cost. One can use different strikes, such as out-of-the-monies, to provide a larger range for the near-term options to expire worthless.

But the concept is the same; let these calendar spreads exploit the accelerated time decay of the options with one week remaining to help you be better positioned to ring in the new year.
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