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The significance of 'Theta' for options traders: Options 101

When it comes to options trading, there is so much to keep in mind — from calls and puts (and whether they're short or long), but even that just scratches the surface.

RBC Capital Markets Managing Director and Equity Derivatives Strategy Amy Wu Silverman joins Jared Blikre for Yahoo Finance's Options 101 special, helping explain the phenomenon known as theta — or options' value decay as time passes — and using Meta Platforms (META) and Uber (UBER) as examples for call and put option trades.

Editor's note: This article was written by Nicholas Jacobino

Video Transcript


JARED BLIKRE: Welcome back to Yahoo Finance. I'm Jared Blikre. Harnessing the power of options can be a tricky road to navigate. So we put together a guide to investing in options along with some trade ideas for newcomers. And this is the latest installment of Yahoo Finance's Options 101 sponsored by Tastytrade.

And joining us here to discuss is Amy Wu Silverman. She is the RBC Managing Director and Equity Derivatives Strategist. Amy, thank you for joining us here today. I want to go draw everybody's attention to the YFi Interactive, where I have a couple of definitions. This is basic stuff for options, calls and puts. You can go long. Call, that is a right to buy a stock. If you're short, it's the obligation. And it's the inverse if we're talking about puts.

But I want to move on to a topic that I was talking to you about offline. You said your number one recommendation to traders is that they have an idea of a catalyst in mind when there's with respect to a trade. And this ties into the idea of theta. Just wondering if you could break this down for us.

AMY WU SILVERMAN: Sure. Good to be here. Yeah, you know, when I was thinking about when I first started in options, what was the least intuitive part of it, it's this concept of theta decay. So, you know, I think a lot of folks when they come into options, they probably have a stock background. And in stocks, it's something you can simply buy and hold. So the Warren Buffett idea of if it's something that is attractive value, you just close your eyes and then hopefully, it has compounded growth.

Unfortunately, options don't work like that. You are fighting theta decay from the very first day if you are long options. And that's simply to say if really nothing is going on in your underlier, that option is going to expire worthless at expiration. So theta decay is a way of thinking about the amount of bleed that you're going to get in that option if nothing happens, which is why it's really important to think about if something is going to happen in the stock that you've chosen for that option.

JARED BLIKRE: All right. Now let's get to a couple of examples here. First, I want to introduce the concept of the covered call. We covered a couple of these last week, no pun intended. This is when an investor sells a call option at a set price and expiration date on a stock. And this is key that the seller already owns in an equivalent amount. So you own the stock, and you're looking to place a trade against it, sell a call against it.

And in this case, we're talking about Meta. And we're looking at the selling the one-- the 485 strike price here, that call with an expiration of March 15, while you own 100 shares of the underlying. Can you break down this trade for us and how you're approaching it?

AMY WU SILVERMAN: Yeah. So the reason I chose Meta for this example is, in this case, when you're selling a covered call, you're doing the opposite of being long, a call option. So when you're selling the call, instead of that time decay, that theta decay going against you, it's actually working in your favor. You're actually hoping that every single day not much happens, and you get to just keep that premium in that call option, because you've sold it. You get that nice yield. And again, you're covered-- you've covered there. You're long the stock. So this is not a naked short option position.

In, specifically, the case of Meta, this is a company that just had earnings. And if you remember last week, it was actually up 20% on earnings, substantial move, really wild. And, you know, hopefully, if you've been long in Meta, you're pretty psyched about that. But the other thing that we know is that a big event has already passed. And another big event, perhaps its next earnings is probably not going to come for another quarter.

So this is a place where we would like not much to happen. And those 485 calls that you're selling is taking advantage of the volatility risk premium that's historically baked into almost all options. You're getting about a 1.5% yield. But again, that's for about a month in time. And again, you're betting that not too much happens. If it does, your stock gets called away at that 485.

So you do retain a little upside in this trade from where we were. I think the last I checked was trading around 456.

JARED BLIKRE: Well, let's take a look at the-- well, this is not going to be a perfect reverse trade, but Uber, where we're looking to buy a protective put. So instead of selling a call and letting time decay work for us, we are buying a put here on Uber. And kind of explain the timing with this, because we're looking at an expiration of February 16 here.

AMY WU SILVERMAN: Yeah. That's right. So this is a relatively short dated trade. So obviously, again, that time is not in your favor. But we do have two events that are coming up in Uber. The first is on February 7th. It's actually its earnings date. And then Uber actually has an analyst day, too, where the company talks to different research analysts across the Street, who cover the company, February 14, on Valentine's Day.

So you're really getting two events in the span of the time before that expiration, which is February 16. So again, when you're long volatility, you've got that theta decay not in your favor, you really want some opportunity for something to happen. In this case, we have two potential catalysts, which could drive volatility and hopefully protect your downside if those events are negative.

JARED BLIKRE: All right. Those catalysts, the word of the day here. Got it. Thank you very much for your time. That will do it all for us in this segment.