The 3 Silent Killers Draining Your Options Trades

All right, tell me if this has ever happened to you before. You're an option buyer and you bought an option contract and whether that was a put option or a call option and the stock went in your favor, but somehow you still ended up losing money on the trade. How could that even be possible? You've always been told when you're buying options, all you have to do is get the stock direction right, but you're finding out even though the stock is moving in your favor, you're still losing on your trade. So, it it's not because you're a bad stock picker and it's not because you just have bad luck. It's because there's three silent killers that are working against an option buyer and you may not even know it yet. So, in this video, I'm going to talk about what those three silent killers are, how you can see them and what you can do about them. All right? And so, let's just jump right in. All right, everyone. Lee Lowell here from smartoptionseller.com. So, what we're talking about today are right here, option buyers three silent killers. As I just said, you're you bought a call or you bought a put and the stock went your way, but you still lost money. It's incredible and it's horrible and and it's very, very frustrating and I hear from a lot of option buyers all the time. They tell me, "Lee, I did everything right and I still lost money." Well, let's go through the three silent killers that you can see on your screen right here. This is the cheat sheet that we always have out. I'm going to talk about each one of these and then we're going to talk about a little bit later on a tool that you can use that I created that you can check before every single trade that's going to tell you whether the trade is, you know, uh uh a green for go, you know, a yellow for medium and red really bad. So, we're going to talk about the little little bit later. So, let's talk about the each killer here and I'm going to show you we're going to pull up the the calculator as well. I'm going to show you how that works and you so you can see with real numbers how each of these and you may be affected by one, two, or all three of these, okay? Um so we'll look at the option calculator and I'll show you some some numbers. But let's talk about each one so you know what they are. Number one, the first killer is theta decay. Some of you may not even know what this is, but it is real. When you buy an option contract and it do you know, whatever the expiration date is, every day that you hold that option contract, you are going to lose a little bit of money every single day regardless of whatever else happens in the world for that trade, for that stock, whatever. You are going to lose money every single day. That is called theta decay or time decay, however you want to say it. And just because we turn the calendar to the next day, your option that you're holding is going to lose money. And the closer you are to expiration, you're going to lose money to theta decay even faster and bigger. Each day that theta is going to get bigger and bigger, so you're going to lose money more money each day. The closer you are to expiration. I'm going to show you that with the calculator. The next thing is what's called IV crush and IV stands for implied volatility. One of the inputs that gives an option its value is what's called implied volatility and implied volatility is just the market's best guess of how the stock's going to fluctuate in the future. And implied volatility is an actual number and that number gets plugged into the uh option calculator or the option pricing formula and it helps create an option's value. Now, the the term IV crush is what happens, you know, before an event happens. We're talking like an earnings announcement for a company, an FDA announcement, a government report, you know, government reports happen all the time. So, what happens is people flock to the options market and they buy up calls and they buy up puts depending on what their directional assessment is and all that buying demand pushes up the option prices artificially right before the the announcement. And once the announcement is known and comes out and everyone sees what the what the real results are from that announcement, IV implied volatility drops dramatically. It gets the air gets sucked out of it and that's what's called IV crush. So, after the announcement is made and all the the results are now known, there's no uncertainty anymore. And so, the implied volatility drops, the options value drops, so you're there holding this thing that unless the stock moves greatly in your favor, that option value that you're holding is going to lose a lot of money or a lot of value, more than than what you paid for it. So, that's what's called IV crush and you and you can read the little description here. Now, the third killer here is what's called bad strike / bad expiration selection. So, a lot of people will gravitate towards buying what's called out of the money options and those are the cheap dollar-wise options, but they really need the stock to make a big big move whether you're you're bullish or if you're bearish, the stock really needs to drop hard um in the amount of time that that that you've taken. So, the the horrible combination here is not only are you buying these out of the money options, but you're also buying very short-dated option like one day's to expiration or a zero DTE or even one week. It's giving you such little time for the stock to move in your favor. If you're not a good stock picker, then you definitely don't want to be trading very short-term options and buying those out of the money options, whether it's call options or put options depending on which strikes you buy, the stock really needs to move very far. So, all those things together you can be prone to either one, two, or all three at the same time, and you're going to and you're never going to make money as an option buyer because these things are working against you. So, let's jump into the option calculator and I'm going to show you the numbers of how that works, how theta decay works, how IV crush works, and and bad strike selection. And what you'll see from the tool that I that I have, um you can put in all these numbers and it'll show you, you know, what are the chances of your trade really working out. Okay, so let's jump into the option calculator now and we're going to go over to barchart.com, one of my favorite websites for free free and paid tools. I'll also have links down in the description for for barchart as well. So, what the option calculator does, if you never use an option calculator, what it does it allows you to put the inputs into the calculator and it'll spit out uh all the things that you need to know. Now, up here are the input parameters, 1 2 3 4 5 6, and down here, right in this section, is the outputs, okay? And the two things that we're going to really look at today are the theoretical price, which is the options value itself, and we're going to look at, right here, theta, okay? Now, there's theta is one of the Greeks. Okay, these are the Greeks, delta, gamma, vega, theta, and rho. And today we're concentrating on theta. And um so what I'm going to do is I'm going to put in some prices here in the input section and I'm going to move some of them I'm going to move the days expiration around and we're going to move the implied volatility around and show you holding everything else constant, we're going to just move one of those pieces, I'm going to show you how that really affects the options value. So, when you go to barchart.com and this is the their free calculator, you can go up and click on the options tab up here and you go down and click on this option calculator. And you type in a symbol, I typed in Apple and what it does is it defaults the information here for you, okay? So, Apple closed at $305.93 and right now we're looking at call, you can click on the drop down, it'll you can choose call or put and you can choose the expiration date. So, what we're going to look at here is you know, very short-term expiration here, this August 21st, 2026. It's got 6 days left to expiration here, the the uh stock price and and we're going to look at the the the at the money, the strike price, okay? So, a lot of people will will gravitate towards at the money strikes as well. The at the money strike is the strike price that currently resembles the current stock price. And the interest rate and the volatility and the dividend yield, all of these numbers get defaulted by Barchart. They default into them for you. So, you don't really have to change this unless you want to, but we're going to change one of these to show you how it works. So, we're going to work on the theta first and show you how that changes. Now, when you go down here, you can see with the inputs here, theta is at 0.299. So, that's let's round up to 0.3, that's 30 cents. So, this is actual cents per day uh how much you're going to the option value will lose uh in 1 day's time, okay? So, right now the option costs theoretical price $3.98. All else being equal, tomorrow when you turn the calendar, you're that option value is going to lose about 30 cents per contract. So, instead of it being $3.98, it's going to be $3.68 tomorrow. Okay? The theta is is is what's going to happen for the next day. So, as you're an option buyer and you're sitting there and you think your options worth $3.98, you wake up tomorrow, then all of a sudden it's $3 and and and uh 68 cents. You've just lost 30 bucks. Okay, that's 30 actual dollars that you're you're giving away just because of theta or time decay. Now, I'm going to take this down to 5 days. I'm going to change the days to expiration to 5 days and you're going to see how this option value is going to change. Okay, let's change this to five. Okay, so there you go. You actually lost 31 cents. It went from 398 to 367. So, you woke up the next day. Now, you're $31 poorer as an option buyer. Okay. So, let's just move this out to say 30 days. Okay, so now you can see the theta is only 14 cents per day. So, the longer out in expiration you go, the smaller the theta decay will be. So, one of the things you can consider is, well, if I don't want to lose so much money to theta decay, uh maybe I should go a little bit further out in time because I won't lose as much money each day. At the same time though, the you can see the theoretical price is $8.55 or $855. That's what it would cost versus $398 if you had bought that 6-day expiration. So, there's always a little bit of a trade-off. Okay, you go out further in time, the option is going to cost more, but yet you're going to lose less money to theta. Same thing here. Now, you can see when we change this from 30 to 29, we're going to move it by 1 day. So, theta is 14 cents. If we go down by 1 day, now theta is still in that 14-cent range. So, you're not losing as much on that 1-day move, but if we go back to the Let's go back to the 6-day. Okay, so theta is just about 30 cents. When we go down to 5 days, now it's 32 and 1/2 cents. So, it went up by 2 and 1/2 cents in that on that one-day period. But, if we started at 30 days and went down to 29 days, the theta was was very small. So, again, going out further in time, you're going to lose less money to theta the further out you go. As these days to expiration get really small, you're the theta really ramps up. It really ramps up. So, you have to understand if you're playing with very short-dated options, you got to be really good at moving at getting the stock direction right. Now, I want to show you how how that works. So, let's just say we got 6 days left here, and you know you're going to lose 30 cents to theta. So, how does that How do you get past that? Well, that means the stock has to move by at least 30 cents per share just to offset that. Okay, so let's just take up we we're going to knock this down by one day, and we know this is going to go down to $3.60. That means Apple's price needs to go up by about, you know, 30 cents roughly to at least counteract that. Okay, so let's take this up to uh we know this Let's take this down to 5 days, and in order to get it back up to 398, we're going to move Apple up to, let's say, 306.25. 306.25. Okay? So, that still hasn't even brought you back up to the $3.98. So, let's go up to 306.50. Okay, so there you go. You're You've You made You've covered your decay, okay? But, the stock has to move up. So, if the stock's not moving in your favor, which is what you need in the first place, you're going to lose to that theta decay. So, you can see how one kind of will balance out the other. But, if the but if one doesn't balance it out, you're going to lose money. All right, so let's get that cleared up. Okay, so what was this? 30593, okay? And we'll bring this back to 6 days. Now, let's talk about how the IV crush works. Okay? Now, right here, volatility, you can change this number as well. It's right at 21.77%. Let's just assume that let's just assume there's Yeah, let's just stay at 6 days expiration and Apple has their earnings coming out tomorrow, right? And over the you know, the the last couple days as everyone's buying up calls or puts depending on what their directional assessment is, instead of volatility being 21.77%, the volatility starts moving up to 35% cuz all that buying demand brings up the volatility, the market makers have to keep raising their prices because everyone's buying these things. So, the volatility starts to creep up, you know, as as the earnings date starts to, you know, get closer, people say, I need to get in, so they keep buying these things. So, the implied volatility starts creeping up to right now we're at 35% and you can see this option is now worth $6.04, okay? Now, when we move this down to day five, not only are you going to lose to the theta decay, which is um now 477 47 cents, that's because volatility jacks up the prices and it also jacks up the theta. So, if you bought this option right before expiration, and let's say you bought a call option, okay, you bought a call option, which is what we're looking at here, and it's $6.04. You've paid $6.04 for it. Now, tomorrow after earnings come out and this thing drops back down to 21%, okay? Now, this option is worth Well, let's take this down by 1 day. So, now the option is worth $3.57. You paid $6 for it. Okay. So, you lost to the IV crush. Now, in order for you to get back up to $6, where does Apple price need to go to? Let's say Apple went up by $3 to let's just say it went up to 309. Okay. So, Apple went up by $3. You still haven't recovered your $6 option value. Let's say it went up to 310. Okay. So, there you go. There you covered your option purchase. And Apple had to go up by five bucks per share. What if Apple only went up by $3 per share? You'd still be losing on that option that you bought because of not only the IV crush, but for the theta decay as well. So, even though the stock went in the right direction, you you bought calls, you thought the stock was going to go up, and the stock did go up, but you still lost money unless the stock went up far enough to cover not only the IV crush and also the theta decay. So, your stock picking abilities need to be really good um in order to cover something like buying right before an earnings announcement. There you go. So, I want to show you how those numbers work. Now, now the other thing is we talked about bad strike, bad expiration thing. So, let's take this down to three back to 30 305 uh 93, which is where it was in 6 days before expiration. And you know, the numbers were whatever here. It was 21 was a 21.77 or something like that. Okay. Yeah, $3.98. So, the other thing is that, okay, you know, Apple's earnings are coming out and you think the stock's going to go up, so you end up buying again a short dated option that only has 6 days left to expiration, and you're going to choose it an of the money strike because you don't want to pay a lot of money. You only have maybe 50 bucks to to to work with this thing. So, let's move up to Let's just say you're you're really bullish. You think Apple's going to go up to $315 a share. Um you know, by tomorrow. And you're going to have a blowout earnings and and you're really bullish. So, the option value is 73 cents. So, you're thinking, "Okay, that's 73 actual dollars. I'm going to I'm going to risk 70 It's only $73. I'm going to risk $73 and buy this thing." Well, okay. So, let's take this down tomorrow, and we got 5 days left. Now, it's worth 55 cents. Um the vol- Actually, let's bring up Let's let's start over here for a second. Let's bring up the volatility, and that was getting up to 35%. Okay. So, if you only didn't want to spend that much money, you even you had to go out further in expira- option strike. So, you can buy the 320 call. Okay. Apple's at 305. You think it's going to go up to 320 within the next 6 days. So, you bought You paid this 30 bucks for this thing. Okay. And now, IV crush comes in and we'll bring this back down to 21% say and this down to 5 days, and Apple went up to $315. Okay. So, actually made some money. Okay. You're making some money here. That's good. Your strike price is 320. And so, you really need the stock to move. So, Apple moved $10, which is pretty a pretty big move for Apple. If it only went up to 310, okay, now you're still sitting at your your 30 cents here. So, the stock did go up. You're not making any money. Um you really need the stock to go up pretty good. So, if it went up to, you know, 315, you can make maybe 100 bucks. So, you have to be really good at picking the stock direction and the stock really has to to do what it's supposed to and really has to go up far. So, if you're picking deep out of the money short dated options, it's going to be really hard for you to to make the money. IV crush, theta decay, bad strike selection, all these those three killers are working against you whether you know it or not. You may not never have known this, okay? So, those are the things that I wanted to bring to your attention that if you keep buying options and you get the stock direction right and you're still losing money, you have to pay attention to these three things, okay? Now, I talked about I have a tool that I created that can help you decide ahead of time whether the what you whether your trade is, you know, could work out for you or not. So, I want to show you that that tool right now. And let's go to that here. It's called the we call the gut check the gut check tool, okay? Now, get rid of that. Now, what I wanted to show you is how it works and when you run it through the gut check, what you're going to do is you're going to put in your stock price. Let's just say the stock's at 100 and you want to buy a call, you know, you can toggle between call and put and we're going to you're let's just say you buy the 105 strike. So, you're buying this out of the money thing and let's just say assume you paid uh $1 per contract for it. So, that's $100 and the expiration date is let's go out to the September 18th expiry. So, 33 days expiration, which is not so bad. And one of the things that you can check also at barchart.com is the IV rank. Now, the IV rank tells you where that volatility is compared to itself over the last year. Is it high, low, whatever, okay? So, let's just assume IV rank is high and implied volatility is the actual volatility that you can get from your broker's chain. Let's just say that right now implied volatility is 45%, okay? And the delta of the option, which you can also get from your broker's platform, in this case you're buying an out-of-the-money strike, so let's just assume that delta is um 15 15 delta. Okay? Deltas range from 0 to 100. And your price target is you're bullish, so you want the the stock to go up. So, you're buying the 100 strike call, so you're figuring, you know, your target is $105. Now, you can toggle this on if the earnings are before expiration. If you're buying this thing before earnings, you can turn this on if if earnings isn't a thing for you, you don't even have to worry about that. So, what the what the gut check tool tells you is that your break even is $106, okay? So, the strike price of 105 plus the premium cost, that gives you your break even. Now, the break even is past your target, okay? If your target's $105, your break even's 106. So, it's already telling you, the tool's telling you that the stock has to go even higher than your target. Now, what the other things this is going to tell you, it's going to check the three killers and how each one ranks for this specific trade. Killer number one, theta decay. It's going to It's telling you it looks pretty good. You got a solid runway. 33 days gives you your thesis to breathe, okay? Theta is a slow drip and you're going to lose about 8 cents per share per day, which is $8 per day, okay? Now, killer number two, IV crush, okay? This is a problem with this trade. Volatility's expensive. IV rank at 70 means you're buying at the top of the fear curve. Now, IV rank goes from 0 to 100, okay? So, 70 is, you know, kind of expensive. So, it's telling you that you're you're potentially buying an option that has higher volatility than where it's been in the past. Okay, number three, the killer number three, strike and expiration. Contract is fighting you. This is a problem. You got two One looks good and you got two problems. Break even is 106 and your target's 105. Okay, so that's that could be a problem. So, the summary here is your trade has problems. This trade has problems. At least one of the three killers is working hard against you. Revisit before you click buy. Well, okay, so you got IV crush and strike and expiration. So, there's two of them. Two of them working against you at this point in time. So, you can use the tool to check before each trade that you're thinking of buying. Okay? Make sure you understand what you're getting into. You need to understand how if and you know, IV is implied volatility, whether that's high or low. You need to understand the theta decay. You know, you got to check all these numbers. So, instead of doing it all manually yourself, you can run it through the gut check tool. Now, down in the link in the description, I put down in the description, I put the link for the gut check tool, so you can so you can read about it there. And then along with that comes a you know, a guide that I wrote, a 19-page guide that goes through each one of these killers a little bit more. It has a a checklist, a seven-step checklist before you enter the trades as well. So, even along with checking the tool, I've got the seven-step checklist that you can look at as well. Okay, down in the description. All right, that's it. I hope this has been helpful for you. Make these videos to help out the trading community. We all want to be better traders. Give me a thumbs up. Give me a like. Leave me a comment. Send me an email. I'm always here to help you. And um on the screen here, I'm going to put another video for you to watch. Maybe it'll help enlighten you in your own options trading. All right, that's all for me today. This is Lee Lowell. I'll see you in the next one.