Dan Passarelli MarketTaker.com
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There are two things in life of which a trader can be certain: Death and theta. Option theta can be used to the advantage of a clever trader. But to be successful, there are a few things all traders must know about theta.

Time Decay
As the amount of time until expiration decreases, so does the value of the option, assuming all other pricing factors are held constant. This is intuitive when one considers  that options with less time until expiration have less utility to a trader. Therefore, as each day passes, the option has less use, and consequently less value.

While this is an obvious detriment to option buyers, it is a bona fide benefit to option sellers. Though the short option player retains the risk of volatility (in terms of gamma and vega) time always helps.

Theta Optimization

All thetas were not created equal. First, shorter-term at-the-money options have higher option thetas than their longer-term counterparts. Traders looking to squeeze the most juice out of their options find it in these shorter-term plays.

Next, at-the-money options have a higher theta than in-the-money options or out-of-the-money options. At-the-moneys are meatier in terms of time value, therefore must lose value at a faster rate.

Word to the Wise
While it seems obvious to sell the shortest-term at-the-money option to eke out the most theta, the risks can increase with these options as well. Short-term at-the-moneys also have the highest gamma. That means, stock volatility has more of an adverse effect on these options than their alternatives. Plus, selling at-the-moneys provides less of a buffer than out-of-the-money options.

Dan Passarelli is the author of the book Trading Option Greeks and the president of Market Taker Mentoring LLC. Market Taker Mentoring provides personalized one-on-one mentoring for option traders. The company website is http://www.markettaker.com.

Dan started his trading career on the floor of the Chicago Board Options Exchange (CBOE) as an equity options market maker. He also traded agricultural options and futures on the floor of the Chicago Board of Trade (CBOT). In 2005, Dan joined CBOE’s Options Institute and began teaching both basic and advanced trading concepts to retail traders, brokers, institutional traders, financial planners and advisors, money managers, employees of the SEC and Federal Reserve Bank, and market makers. In addition to his work with the CBOE, he taught options strategies at the Options Industry Council (OIC). Dan has been featured on television and radio and has written numerous articles in the financial press. Dan can be reached at dan@markettaker.com. He can be followed on Twitter.