Option Premium: How To Reduce Premium As Expiry Date Is Getting Nearer.

by Dinesh
(Delhi, Delhi, India)

How to reduce option premium as expiry date draw near?

How to calculate it and determine if it is beneficial to take this time?

Dinesh Kumar

Comment on "How to reduce premium as expiry date is getting nearer "

TSO Reply: Hi Kumar. As a recap, option premium is make up of 2 elements:

Intrinsic Value plus Time Value

The time value of an option decreases as time passes until, at expiration, become zero. This time decay process, however, is not linear. At expiration date, the option will be entirely make up of its intrinsic value. Therefore with all other factors that influence option premium being constant, a long term option will worth more than a short term option.

Hence, to answer your first query, option premium will naturally reduce its value as expiry date is getting nearer (with all other factors being constant). The effect is more obvious especially on the last 30 days.

To add in a bit more information, you may use different option strategies such as Bull Call Spread to reduce the cost/risk of the trade. Do take note of the various risks and rewards of each strategy before you invest any money.

As option expiry date draw near, this also mean the risk/return potential of the trade also accelerate over time. This is because near-term options cost lesser than long-term option, they have the potential to profit more from an unexpected, large move in the underlying stock.

On the flip side, their time decay can severely turn your profit into a loss position easily as well. The risk of time decay is great, but the return of substantial savings (reduced investment) or large profit is also great.

Therefore option with accelerating time decay is especially profitable and beneficial to you if you are certain on the outlook of the underlying stock at expiration.

Have many profitable trades ahead!

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