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You can see, as we’ve gone through this video, the prices are constantly changing within a few cents. On average, our overall total of all of our Theta, is a positive 36.20.
That means, for as long as we hold these positions, and price remains fairly constant, we will collect an average of $36.35 on this position. That’s how money is made.
Since options decrease in price, the closer they get to expiration, we should see our Theta position increase with time, the longer we hold this position, given the fact that prices remain relatively stable.
When they do not remain stable, that’s when adjustments are necessary. It’s really important to understand how to do adjustments on positions that go against you. That’s where the real profit in our system is. There are a lot of people who put positions on, that do not know how to adjust them. They simply take their losses, or take their profits, and go home, and don’t realize that even though some of their positions had a small loss on them, they could have saved those positions.
We always want to put on positions that are positive Theta. We never want to get into a position in which we are negative Theta. When you are negative Theta, that means that’s the amount of money that you lose, on a daily basis, on that option. Let me give you an example.
Let’s say we go to a stock – let’s take Ford, for an example. On the May 2008 option, the May strike price at 9 is selling for 18 cents, and you can buy it for 19 cents. If we were to purchase that option, and analyze that position, we would see that right here – under “Price slices,” – the current position of that option is a positive 30 Delta. That means that for every point, for every dollar that stock goes up, we would make $30, which is good. Our Gamma is 30. It’s positive, because when you purchase calls, or purchase puts, you’re always positive Gamma.
However, your Theta is a -81. In this case, a -81 cents. What does that mean?
That means that every single day that this price does not move, you lose 81 cents on the price of that option. The fact is, that option will actually lose money, even if the stock increases, to the point where it gets close to the 9 strike that you’re buying.
So, when you purchase a long call option, not only do you have to be absolutely correct in the direction, but you also have to be correct in your timing. You’re losing, on a 20 cent option, 1.6 cents per day.
That’s why we always like to be positive Theta. We always like to have Theta working in our favor. Option prices to decline in price, as they approach expiration. The time value, specifically, will decrease, as we get closer to expiration.
Let’s take a look at Vega, for a second. Vega is actually one of the most important components of the variables that affect the price of an option. Vega is the measure of how much a particular option will change in value, because of a 1 point change in volatility. It really is the most powerful of all the Greeks. It can dramatically affect the position that you have, because of the change of volatility.
In the case of our demonstration account, we are a net positive 53 Vega. That means, for each $1 change in increase in the Vega, or the volatility, of the market – we will gain an additional $53 in profit. But what is Vega?
Vega, as measured by the volatility index of the CBOE, whose symbol is $VIX – normally known as the VIX – is a measure of volatility in the market. Volatility in the market goes up. Stocks normally go down. When the volatility decreases, stocks go up.
The measure of the volatility index is based on the measurement of the number of puts being purchased on the CBOE. The more people purchasing puts, the more fear there is in the market. People are afraid that prices are going to decline, so they will go out and purchase puts.