Time decay, also known as theta decay, is the rate at which the value of an option contract decreases as time passes. Theta is a measure of an option’s sensitivity to time decay. Time decay accelerates as expiration approaches and is most significant in the last few days before expiration.
Time decay is often referred to as the ‘risk’ of owning options because it represents how the value of an option contract can decline over time. While time decay is a risk, it’s also an opportunity for traders who understand how to take advantage.
Day traders have a time decay risk every time they enter a trade, but they also have an opportunity to take advantage of time decay by selling options that are losing value.
Time decay is essential for all options traders to understand. Still, it is significant for day traders in Hong Kong because day trading generally involves a lot of short-term contracts with high levels of leverage. Even small moves in the underlying asset can have an enormous impact on the value of the contract.
Theta decay is more likely to occur in day trading than in scalping because day traders hold their positions for extended periods. Therefore, if you are day trading, you should be aware of theta decay and how it can affect your positions.
How can traders avoid time decay in day trading?
Use various orders
Traders can use limit orders to buy or sell an asset at a specified price or better. A limit order gives the trader more control over the price at which their trade is executed.
They can use stop orders to buy or sell an asset when it reaches a specific price to limit losses or lock in profits.
Use a trailing stop
A trailing stop is an order that automatically adjusts the stop price as the market moves in your favour. This type of order can help you stay in a winning trade while protecting your profits.
Manage your position size
Position size is the number of contracts or shares that you trade. Day traders should manage their position size to avoid exposure to theta decay.
Take profits regularly
Regularly taking profits can help you stay ahead of time decay. When you take profits, you are essentially selling an option that is losing value.
How can time decay be beneficial when day trading?
Sell options that are losing value
If you are day trading, you can sell options that are losing value. It is an excellent way to take advantage of time decay.
Sell near the money options
Near-the-money options have a higher theta than out of the money options, meaning they will lose value more quickly as expiration approaches.
Sell short-term contracts
Short-term contracts have a higher theta than longer-term contracts, meaning they will lose value more quickly as expiration approaches.
Time decay can be beneficial for day traders if they understand how to take advantage of it. The key is to sell options that are losing value and manage your position size so that you are not too exposed to theta decay.
Benefits of intraday trading with options
The expiration date is at the end of the day
It means that you don’t have to worry about theta decay because the contract will expire before it can lose much value.
More time to make a profit
Since you are only day trading, you will have more time to make a profit than if you were holding a longer-term position.
More flexible
Options are more flexible than other types of securities, so you can tailor your trade to fit your needs.
Potentially higher returns
Because options provide the potential for leveraged gains, they have the potential to generate higher returns than other types of securities.
Risk is limited
The most you can lose when buying options is the premium you paid. It is different from other securities, where your losses can be unlimited.
Can trade around your schedule
Since you are only day trading, you can choose when to trade based on your schedule. You don’t have to hold a position overnight like you would with other types of securities.
Click here to day trade options with Saxo.
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