How to pick the best option contract with low risk
In a recent article, An easy guide to picking the right option contract for option trading, which is a guide on how to pick the best option contract. And even though all the boxes checkoff, your contract is still losing value. Why does that happen?
The answer is simple, theta is burning the premium on your contracts. To combat this issue, you just need to pick contracts with low theta.
Example of a bad contract: Weekly contracts
Let’s take a look at a weekly $SPY contract:
Look at the highlighted column. Theta is greater than the Delta value.
The contract doe’s not have enough intrinsic value for the contract to be on your side when the stock moves sideways.
My rule thumb is, Delta has to be greater than Theta, and Theta has to be below 50¢.
Example of a good contract: Monthly contracts
Let’s take a look at a $SPY contract that is weeks out:
Do you see the Delta vs Theta? This is a contract that has slow time decay because theta is under 20¢ and every time it moves a dollar on your side the contract gains more than 40¢–depending if you get ITM (in the money), ATM (at the money), or OTM (out of the money).
The other pro to this monthly contract is that, you have time on your side. Sometimes wild story may pop out and make the stock move drastically to the opposite direction.
With 30 days expiration or greater, you can minimize the risk.
Conclusion
Weekly contracts tend to have very high theta and no intrinsic value. Because of that, weekly contracts can be very volatile.
On the other hand 3 weeks out or even monthly option contracts can put a nice amount of cash in your pocket, with minimizing risk. This is a much better approach for option traders who have a full-time job or are looking to transition.
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