When to close a short option position to maximize the return from premium decay?

Quote from ktm:

I'll give it a go from another angle.

I usually take profits around the 75% - 80% mark. In your case if you take $2.60 in premium...maybe 50 - 60 cents or so. Others use specific deltas to guide the closure...maybe in the .15 - .10 range, although that may coincide with the 50 - 60 cent mark in this example.

You also have to consider the amount of time involved in the trade. If you have most of your premium very quickly, you may want to close early. If a trade is to last 30 days and you have half your profits in 5 days, lots of people like to close that. The way to approach that is the risk remaining of the position reversing vs. the premium remaining to be realized.
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Good points;
some use differnt %% , but it can be very counterproductive to post specific numbers, even though i have done that some. But mostly in much more liquid markets.

Again, good points:cool:
 
It's a mistake to look for some type of formula.
You exit when common sense and analysis of your specific stock and overall protfolio tells you to.
For me, if I'm on more margin leverage than usual, I'll close a trade earlier than when I'm not as heavily margined.
If I'm super deep otm, I'm less likely to close a trade than when I'm only slightly otm...... assuming similar time remaining and similar % profit locked in.
If i think the market is headed off a cliff, I'm more likely to close a trade early, regardless of the % locked in.
If earnings are pending, I'm more likely to lock it in than if I don't see much potential risk ahead.
If I'm in a sector that is extremely volatile, I'm more likely to lock it in early, than if I'm in a more stable sector.
If I see another trade I like and I need the cash to initiate it, I'm more likely to close another profitable trade early, than if I don't need the cash.
If I'm more concentrated in a stock or sector, I'm more likely to lock in a profit early, than when I'm more intelligently diversified.

There are times I will close a trade when i have 40% or 80% of the profit locked in and other times I won't.... not even for 90 or 95%.
It could be any of the issues discussed here or on this thread, or a "combination" of issues that i base my decision on.
I suggest basing when on "common sense and analysis" of your portfolio, and the market, vs some set formula range...... particulalrly if that range is based on someone elses opinion.
It's your stock, your money, and thus it's your responsibility to use your own common sense and analysis to manage it's risk.
Going out to watch the UFC fight.
 
Quote from dragonman:

Although the most theta decay occurs near expiration, it may not be relevant to my question, as it relates to maximizing return on a position that was NOT opened near expiration. Therefore if 80% of the premium was decayed after 50% of the time has passed, then anyway I will not be able to earn more than 20% of the original premium by holding my position during a time which is equal to the time that it took me to earn 80% of the decay.

And if so, the fact that near expiration the decay is higher will not help me, as anyway I will not be able to earn more than 20% of my original premium during that time.
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this is a very good point.... if you can get half way through a game and be up on your opponent and get 80 percent of the winnings.. your expected return is higher quitting then.. my point as risk changes it doesn't go away.. trading credit spreads condors and the like are very good for your confidence.. because you can be right alot.. but if your expected return is negative.. then who cares how great you feel about yourself.. not talking about you specifically... volatility "selling" strategies to me shouldn't be a full time deployment.. if vol is mean reverting.. stick to when its reverting to selling options..
there are so many descretionary factors when managing a trade... considering time and leftover gains as a ratio would be a good metric to trade from... right? i mean.. if you make 20 percent of your credit in two days.. think about it.. stick to the birds that are in the bush they say.. equations are something you can formulate yourself..
your using time as a handle for profit.. time is constant and the return on your credit is the variable. so look at it like this.. if you divide the total credit up into a time increment (say days).. make it additive such that your constantly looking at a ratio of percentage profit given the time left.
every day your normalizing your return to time.. so you can see in real time if your in the red or black given the time passed and time left and total credit to be received.. . isn't that the dimension you want to look at it from?
 
Quote from cdcaveman:


every day your normalizing your return to time.. so you can see in real time if your in the red or black given the time passed and time left and total credit to be received.. . isn't that the dimension you want to look at it from?
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Yes, this is the way I want to look at it, thanks. I just thought there may be any specific formula in this regard, but it seems that I should make my own calculations based on the rationale you mentioned.
 
just wondering if the decision to close at a given point in time or profit% or delta would be influenced by the ability [and desire] to roll into a higher or lower strike of the same underlying and same expiry [in hopes] of thereby increasing return.
 
You have to adjust your question to :
"What option expiry should you sell to get the highest decay rather than selling a 4 month option and wait for the highest return"
If volatility goes up, it will increase the premium more than delta decay so I believe there is no exact formula for your system. You will get the optimum result by experience.
1- You should not wait for the right time to get the highest time decay if you know the stock will drop for a reason. You can cover your position and sell the same thing after a few days with higher premium.
 
I think the problem is with the original question. Simply collecting theta should never be a reason to sell convexity. To simplify, you are most probably selling an option for one of few reasons:
A. you have a directional view on the stock
B. you think that implied volatility is too rich
C. you feel that a particular side of a distribution is overpriced
So, you should keep the position on if both you have a view that the reason for the trade still persists and you feel that the expected change in the option price (delta + theta in case A, vega + theta in case B and the combination of all three in case C) compensates your for the short gamma/gap risk. If either of the two are wrong, you should take the trade off. Now, how you are going to measure the remaining value of the position and measure the risk is where you can argue till you are blue in the face.
 
Options with long expiration have low theta value, that beig decayed very slowly, so it's not worth the risk of waiting so long.
In my experience (witch is not a lot), decayed positions should be opened at a much nearer expiration period.
 
Quote from sle:

I think the problem is with the original question. Simply collecting theta should never be a reason to sell convexity. To simplify, you are most probably selling an option for one of few reasons:
A. you have a directional view on the stock
B. you think that implied volatility is too rich
C. you feel that a particular side of a distribution is overpriced
So, you should keep the position on if both you have a view that the reason for the trade still persists and you feel that the expected change in the option price (delta + theta in case A, vega + theta in case B and the combination of all three in case C) compensates your for the short gamma/gap risk. If either of the two are wrong, you should take the trade off. Now, how you are going to measure the remaining value of the position and measure the risk is where you can argue till you are blue in the face.
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thats very straight forward... looking at selling options from one perspective like theta will not give you the dimension necessary to deal with all the risks in play.. i've heard things like..you get paid in theta for taking gamma risk.. which makes complete sense but doesn't take into account the changing vola assumption.. you may think your getting paid crazy good for your gamma untill your vola assumption goes up..
i personally have made alot of mistakes.. i seem to only learn the hard way.. it has to hurt me for me to remember it.. you can probably look at it from one perspective if you want.. i just wouldn't.. the reason why i've tried to learn as much as i can about changing vola, skew, changing risks going into expiration. is so i can match the conditions with the appropriate limited risk options play.. volatility seems to jump against you hard core constant seller of otm premium.. i just think sticking to one strategy in options limits when you can make plays, and causes one to over play there strategy in the wrong environment.. thats just my experience.. you can't beat a condor in a falling vola market.. just like you so easily can get beat super easy with condors in a super low vola market.. its like obligating yourself to pick up pennies on the train tracks not knowing when the train is coming.. just wait for the wreak.. the pennies will be everywhere..
 
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