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Consistent income trading options: Theta efficiency

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In our quest to understand trading options for income, we often consider improving the efficient use of capital. While ROC (return on capital) is a common metric, another metric being discussed is Theta Efficiency.

Theta efficiency is defined as: Theta / Buying Power Reduction (or margin requirement). It is expressed as a percentage.

Employing theta efficiency with the SPX, we can compare the results for Weekly short Puts vs. Weekly bull Put spreads, and Monthly short Puts vs. Weekly bull Put spreads. We have focused on these two comparisons to determine the validity of statements made by others that the Monthly short Put, with close to 45 DTE (days till expiration), is the ideal approach for the SPX.

We performed two tests using the SPX. For the Weekly comparison, we selected the JAN2 14 with 7 DTE using the Option Chain IV to locate the short strikes for 1, 1.5, and 2 SD (standard deviation). For the bull Put spread, we used $25 for the width of the spread. We simply compared the premium, buying power reduction, and theta and calculated theta efficiency.

For the Monthly vs. Weekly comparison, we selected the FEB 14 Monthly with 48 DTE using the Option Chain IV for locating the three short Put strikes (as above). There were seven Weekly dates (from Jan 3 through Feb 14) representing trades that would occur over the 48 days of the Monthly; we accumulated premium and averaged theta during this period.

The results: when comparing theta efficiency, we found the bull Put spread was more efficient by a factor of two (at 2 SD) to four (at 1 SD). This is consistent for both the Weekly comparison and the Monthly vs. Weekly comparison.

Of interest is the premium accumulated by the Monthly in comparison to the Weekly trades (7 weeks). At 1 SD: $9.60 (M) vs. $11.50 (W); 1.5 SD: $5.85 vs. $5.45; and 2 SD: $3.60 vs. $2.98. As we can see, the total premiums are fairly close, despite the vast difference between buying power reduction (between $19,600 to $28,000 for the Monthly vs. $2,500 for the Weekly).

In conclusion, the theta efficiency test for the SPX clearly shows that the Weekly credit spread is a more effective approach than the short Put Weekly or Monthly (even at the ideal 45 DTE) at every level of risk (1 SD, 1.5 SD, and 2 SD).

If you would like to learn more about options, and how to generate consistent weekly income trading options, go to Options Annex.

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