Time Decay And Selling Premium
Options decay with time in a natural way. Some people, both on an off the trading floor, try to exploit this by selling deep out-of-the-money options for a “teeny” (1/16 of a point) in bulk, feeling this is free money because these options will never be worth anything.
In fact, many traders have made quite a good living using this simple strategy, accumulating positions with thousands of deep out-of-the-money options which expire worthless–that is, until they encounter a takeover situation (or in the case of puts, a market collapse) that causes them to give back in one day everything they ever earned (and more) from this strategy.
The financial graveyards are littered with traders, in some cases well-known traders, who have sold options “uncovered” and have had to repurchase them at undreamed-of high prices.
You can exploit time decay, but you should do it in a reasonable way. Calendar spreads are one way of doing this; we will cover others in future commentaries. But beware of selling options without a proper hedge for those cases where the option becomes valuable.