Spread Trading: An Introduction to Trading Options in Nine Simple Steps

CHAPTER 24

More Time Travel

It was 7:30 by the time everyone had gathered in Lon’s study the next evening. Aaron began the discussion. “The first thing we need to talk about tonight has to do with time frames. It’s something you have to have in mind from this point forward.

“Let’s start,” he continued, “by remembering that you, Lon, always like a lot of time built into your trades. That’s because you like to be long. In a long call you want the market price to go higher than the strike price, and the more time you have, the more likely that is to happen. Same thing for a long put. You want the market price to go lower than your strike price, and, again, the more time you have, the more likely that is to happen.”

“So,” added Nate, “it’s like time is part of the value of the option. The more time an option has, the more value it has. So think of time itself as having value. In fact, we call it time value.”

“That’s why, by the way,” said Aaron, “the further we go out in time, the higher the bid/ask amounts are. Remember that?”

Other things equal, the price of this option will drop day by day just because of the passage of time.

“Sure. We figured that out ourselves. And then you showed it to us on an option chain.”

“Good. And the point is that this happens because the further out in time that we place, say, a long call or a long put, the greater the chance it has of going in the money: it has more time available to it to do so. That makes it more valuable to Lon, which means he will ...