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Potentially you could both be correct or you could both be wrong. Options change
in value for four reason. Time, price of the underlying, interest rates and
volatility. It is true that most of the time erosion occurs late in the life of
an ATM option, but it is not as true for ITM or OTM options. What you really
want to do is go get a option pricing model and run a few simulations of ALL the
inputs. The option GREEKS are essentially what you are looking to understand.
THETA (time erosion)is greatest for short term options as you mention, but so is
GAMMA(the rate of acceleration of the rate of change)so if you are wrong about
direction and your short option goes into the money near expiration it would
"hurt" you the most. So it is very difficult to generalize, because rarely is
only one variable changing.
Look at October 1987 as an extreme example. The market went down huge and
volatility went up huge. You would have observed in October 1987 that people who
wrote short calls(either covered or naked)were surprised to find that in many
cases their short calls didn't decline in value by very much because of the
increase in volatility.
You also mention Leaps .... there is almost no reason to ever short a LEAP ..
either covered or naked. Leaps have very little time erosion(THETA)and
accordingly have very little(GAMMA) which makes an instrument that would most
often be senseless to short. The only justification I've ever come across to
short long options related to tax/timing issues or the need to sell a strike
price that does exist in short term options.
Lot's of web sites offer free option pricing models .. you might want to visit
optionscentral.com for links to various sites.
GREHERT@xxxxxxx wrote:
> I have a question about options. I'm debating a point with a friend.
>
> If you sell a call to make a profit on the premium shrinkage, I understand
> most of the shrinkage occurs in the last 30 days of the call. My friend says
> this is true but if the stock moves away from the strike price, the premium
> goes away very early.
>
> Question: (1) is this true? (2) is it the same for LEAPs?
>
> Thanks for your consideration.
>
> Jerry Rehert
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