The "Sweet Spot" Expiration Date When Selling Options (Part 2 of 3)

What expiration date you select when selling or writing optons can have big implications on the outcome of your trade.

In Part 1 of this series, Best Durations When Buying or Selling Options, we examined the nerdy - but still fun and exciting - option pricing component, theta.

Theta is simply the rate of daily time decay that an option experiences.

And when you're a seller or net seller of options, you naturally want time value to decay rapidly, not slowly.

(And vice versa if you're a buyer or net buyer of options.)

But here's the deal - options with farther away expiration dates have a much lower theta. And the closer an option gets to its expiration date, the more theta accelerates.

That's why I argued that:

• If you're a buyer or net buyer of options, you want to choose longer durations (i.e. expiration dates)
• And if you're a seller or net seller of options, you want to go with shorter durations

So that means when you're selling options, you should just go with weekly options then, right?

Well, it's not that simple.

It's true that the shorter the duration, the higher your annualized returns will be (because you're benefiting from higher rates of time decay).

But the shorter the duration, the less upfront premium you'll collect.

And with less total premium comes less initial downside protection.

For example, think of put selling as a form of synthetic stock purchasing where your cost basis is the strike price less premium collected.

Example: you sell a $30 put expiring in one week for $0.30/contract (or $35 cash excluding commissions).

Ignoring commissions for simplicity, your breakeven or cost basis is ($29.70/share - or $30/share less $0.30/contract of premium).

True, that works out to be around a 50% annualized ROI.

But in terms of protection against the stock trading lower, it's very thin protection.

You see the dilemma:

• The higher annualized returns you want, the less protection your trade will have
• And the more protection you build into your trade, the more you'll gut your annualized ROI

It's mathematically impossible to maximize both components of your short option trade.

The Best Solution - Balance!

What I've found that works best for me is to choose expirations that strike a balance between annualized returns and initial or upfront protection.

And for me, that usually works out to be somewhere between 3 weeks and 45 days.

Basically, I go with the next regular monthly option expiration cycle - unless that starts getting too close.

At that point, I'll start looking at the following month out.

One Size Fits All?

For me, the 3 week to 45 day duration really is the best balance between total premium collected and the rate at which you can book that premium as profits over time.

Only you can decide if it's the right balance for you.

I know many traders who insist on selling weeklies (even inside the Leveraged Investing Club!).

As with just about everything when it comes to option trading, your best bet is to have as much clarity into the process as possible.

That way you can make your own informed choices.

Next - Part 3: Pros and Cons of Selling Weekly Options

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