Picking the right expiration

Picking the right expiration for your stock options can be critical. If you pick the wrong expiration you can be right and still lose money. Let me show you what I mean. You buy a $45 call for $2 on stock XYZ. You expect it to not take that long to move, so you buy it to expire in 2 weeks. The stock move from $45 to $46, but your option is only worth $1. How did this happen? You bought it too close to expiration. While the stock went up the option lost time value.

So, how can you prevent this from happening? You have to buy time, lots and lots of time. During the last 30 days of an option’s life is when it depreciates the fastest. As a rule of thumb, when buying an option, you should buy 2 months more time than you think you’ll need. If you think you’ll only need a month, buy an option set to expire in 3 months. That way you have plenty of room if things take longer than you thought they would. It will also help your options not to lose time value.

When you are a buyer you want to buy your option out as far out as you can. But when you are an option seller you want to sell as close as you can to expiration. This way you will take full advantage of time decay. Picking the right expiration is entirely dependent on what type of trade it is. One of the best things you can do to understand options is to start paper trading with them.