Capturing Theta

Trading Strategy to profit from Options Theta Decay

 

Protecting Theta:

 

Now that we have a Short Straddle position, we have positive theta decay regardless of which direction the market moves. However, a Short Straddle position will lose money as the market moves away from our strike price, also referred to as our Pivot Point. Therefore we will take a directional trade in the underlying as insurance against our options positions. We call this process Protecting Theta.

To protect theta, we trade the underlying based on our pivot point. If the market is above my pivot point, I enter a long position. If the market is below my pivot I enter a short position. Let’s take a look at the possible outcomes.

  • Market Moves Up

If the market moves up while in a position, the short call option will be exercised against us. This means we owe someone a position in the underlying at the strike price of our Short Straddle. However, due to our protecting theta strategy, we have an offsetting long position which is exited when the option is exercised. In this example, we have collected the theta decay from the short call option plus the entire premium from our short put option.

  • Market Moves Down

If the market moves down while in a position the short put option will be exercised against us. This means we owe someone a position in the underlying at the strike price of our Short Straddle. However, due to our protecting theta strategy, we have an offsetting short position which we exit when the option is exercised. In this example, we have collected the theta decay from the short put option, plus the entire premium from our short call option.

  • Market Moves Sideways

If the market moves sideways, neither of the short options will be exercised. Therefore we will collect the entire premium of both options

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