A theta trade? What’s that? There was once a day when 80 percent of the traders I’d talk to at my trading seminars traded nothing but credit spreads, iron condors, time spreads and butterflies: i.e. theta spreads. With the volatility in the market these days, theta spreads have gone the way of long forgotten silent film stars, like Theda Bara. Theda Bara, the infamous sexy vamp of silent film is barely remembered by movie goers today. She never made a film with sound; she had her time and place.
Theta spreads, while sexy in their own time and place, have been usurped by the new stars of this golden era of trading, like volatility plays. Theta spreads involved selling options and were attractive for two reasons: 1) They profit when stocks DON’T move, and 2) They usually produce more winners than losers. The problem, though, occurs when stocks DO move. This is when losers are produced. And when theta spreads lose, they can lose big. In fact, with many theta spreads, often $4 or $5 is risked for the chance to earn $1. Sometimes that ratio is even higher like $10 or $20 risked to make $1.
Traders who were introduced to options in the less volatile periods thought these strategies were manna from heaven. They’d have profitable trades month after month, never seeing a loser. Nirvana! But, when the volatility kicked in everything changed. The first losing month came as a shock to many newbie traders. “How could this happen!?!” It can. And, it does.
To be good at trading options requires versatility. One-trick ponies don’t last in the long run. A deeper understanding of options helps traders adapt to ever-changing market conditions. This is the most important thing that I try and instill in my students at Market Taker Mentoring LLC. Understand the product. Don’t just try and get good at one trick, even if it’s a good one.
Though silent film and theta strategies are both fun nostalgia, their eras are over. Time to move on.
Dan Passarelli
http://markettaker.com
