Why I Like to “Shorten” My Trade (You Will Too)

Last week I loaded you up with information on options timing: the factors that go in to the pricing of an option, what cycles options have, and the option Greeks that determine the premium.

I hope that one didn’t leave your head spinning!

This timing stuff is important if you’re going to put the power of options to work for you.

Now I want to reveal my favorite timing strategy – one I’ve used for over 25 years to “ring the cash register,” and one you can start using right away.

If you’re feeling uncertain about any of this timing, you can always follow along with the “money doublers” I show you here occasionally, or trade along with my Money Calendar Alert subscription service if you’re a member there.

But if you’re a do-it-yourselfer or just the type of person who likes to drill down and see how things work – you’ll love today’s lesson.

Here’s why I like to “shorten” my trade timeframe…

Today I will outline visually – and in writing – why I favor the shorter-term, in-the-money (ITM) options on my shorter-term directionally based strategies.

Before we get there…

Two Decisions to Make Before Picking a Trade

First, let me reiterate that you need to assess two important things on a stock before you decide to trade options on it:

  • Expected price move and
  • Timeframe needed or expected for it to make that price move

If you don’t make this assessment, you won’t know if your trade is working like you want, where and or when to take profits when you get them, nor will you make the best decisions for managing your trade in a loss situation.

Let me spend another minute here showing you why this is so key.

Say you take a call option trade on a stock expecting it to go higher, but have no idea how much higher it could move. The stock goes up $3 and your option increases by $1. You say “Great!” and you sell the option… only to see the stock go another $3 higher. That’s a lot of potential profit you just missed out on. If you saw that the stock had an opportunity to go three points higher, you likely would have waited for that to happen and THEN taken your profits.

How about this. The stock goes $3 higher, the call option goes $1 higher and you say, “I think [operative word here] it will go higher.” How much higher? You don’t know, just higher. Then the stock reverses and goes down $5 and you are losing on your call option.

If you had a tool like Money Calendar that shows average profit/price moves over a specific timeframe at a high percentage success rate – or you used any form of analysis to assess an anticipated price amount – you probably would have seen this $3 move was all it had in it for that timeframe. You would have known to take the profits and wait for another setup in either this stock or another one.

One more scenario. Your stock moves $3, the option increases $1, but you are a few days before expiration, so you sell or else it expires. Post expiration, the stock runs another five points for the next two weeks. You are wishing you had bought an expiration with a bit more time.

Do everything you can to try and assess the expected price move and timeframe needed for that move before entering an option trade.

Why It “Pays” to Set Your Expected Price + Time Moves

  1. You can know when to hang on for more potential profits.You can know when it’s time to take profits – before they dry up.
  2. You can know how much time you’ll need in a trade to maximize your gains.

Ok, let’s get started.

Why I Favor Shorter-Term Options

I’m about to show you the option data for a $57.50 call option on flash memory storage company SanDisk Corp. (NASDAQ:SNDK) for September 2015, January 2016, and January 2017.

Here’s what I want you to keep an eye on…

You’ll see how the shorter-term option has a faster Theta or time decay component. But when the stock moves in the anticipated direction, the Delta and Gamma help the premium or price of that option increase at a faster and more robust rate than the two options that expire later.

Money Calendar for August 24 shows an average profit or price move for SNDK at $4.59 over a 19-day period of time or an end date for the run of September 17.

Here is the chart on SNDK.

Click to Enlarge


I am going to now show you the option data for each month’s expiration for the $57.50 call strike.

September 18, 2015 (37 days)

Click to Enlarge
January 15, 2016 (156 days)

Click to Enlarge
January 20, 2017 (527 days)

Click to Enlarge
The first thing that should jump out at you is the cost of each option, which you can see in the “ENTRY DEBIT” column above (one contract = 100 shares).

  • Cost September 2015: $282
  • Cost January 2016: $548
  • Cost January 2017: $930

If you consider the scenario of risking or spending no more than 2% of a $25k account on a trade, then the last two options exceed that $5.00 per contract cost. That would make the shorter-term or September expiration the pick by default. Or look at doing a loophole trade.

So that’s one consideration – price of placing the trade.

Next, I mentioned Theta or time decay in my last note to you. You can see that the farther out you are, the less detrimental time decay is to your option position.

  • Theta September 2015: -3.5
  • Theta January 2016: -1.6
  • Theta January 2017: -0.8

You can see the 2017 expiration option has the lowest figure of the three for Theta, where the September 2015 has the highest – so the time value that comes out of the option per day is highest.

Now Delta is the price change in the option for the first dollar move in the stock, and you can see the Delta for all three are pretty much the same. But what really helps the option premium increase is the Gamma. Gamma is the rate of change in the Delta and it is highest in the shortest-term option.

  • Gamma September 2015: 5.97%
  • Gamma January 2016: 2.88%
  • Gamma January 2017: 1.56%

The Gamma is listed 5.97%, which is basically $0.06. So for each dollar move in the stock, $0.06 (six cents) is getting added to the Delta.

Here’s How the Numbers Work Out

Again, the September 18, 2015 57.50C is 2.82. The Delta is .54 and Gamma is .06.

This is what the numbers show today, which is before the actual start date for the run shown by Money Calendar, but I wanted to show the number to educate and make the point.

If you are considering this stock and option scenario at that time, look at current numbers on August 24.

Given all other factors stay the same, here is the situation for Delta and Gamma for SNDK.

The first $1 move in SNDK gives the option a $0.54 move, therefore we can expect the option to increase $0.54. The Gamma of .06 would make the Delta now $0.60. The next $1 move higher in SNDK should make the option value move that $0.60, and the Delta then increases another 0.06 to $0.66 and so on.

So on a four-point move, the option premium could increase $0.54 for the first $1 move, $0.60 for the second, $0.66 for the third, and $0.72 for the fourth. Add all those up and you could get a cumulative move on the option of $2.52.

A $2.52 increase to an original purchase price of $2.82 is an 86% move; significantly more than the other two longer-term opportunities and almost a double on the trade.

Here’s Your Trading Lesson Summary:

First, do everything you can to try and assess the expected price move and timeframe needed for that move before entering an option trade.

Second, I favor the shorter-term in the money options, for two reasons:

  • Per my analysis of the stock and its expected price move, I don’t need 500+ days for the stock to reach its target price; and
  • When the stock moves in my anticipated direction I stand to get a higher payout.

I’ll be back with you soon.

Tom Gentile

15 Responses to “Why I Like to “Shorten” My Trade (You Will Too)”

  1. Tom, thanks for the 2 related lessons. I’ve never fully grasped the workings of the Greeks and you lesson have helped me break through. Much appreciated and I look forward to learning more from you. Regards Derek

  2. Thanks everyone! A little more info in that article above than normal, but I thought it was time to step up the education a bit… Especially in tough markets like these… BTW that case study above using our loophole trade is down like practically everything on the long side, but nowhere near the outright call options, let alone the underlying stock. And SNDK wasn’t hit as hard as some of the other techs…

  3. I learned more on the 3 lessons I read from you than the 5 books I read on Stocks & options. Too bad I missed your lesson on Implied vol. & I don’t know if you also gave lessons on how to choose a stock for options,but thanks anyway

  4. Thanks Tom . . . I’m an intermediate options trader and have never really caught on to the true interpretation of the Greeks. For some reason you just made the light switch go ON!!! Very well explained how the Delta and Theta work on the premium. Now, can you do an exercise on when its right to use LEAPS . . . like SDRL is sooo enticing to take a LEAP on current eroded prices in the deep water drillers.
    Love your service and will continue LEARNING and trading along side of your recommendations.

  5. Thank you for your knowledgable education. Please tell me if you have covered call then only can use limit and stop both ? Because my experience both do not go on short option, may be go with long chain option ?
    Have a nice thanks giving.

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