As a trader who is exploring new strategies to increase your chances of profiting, have you ever thought about implementing the theta gang strategy? It’s an options trading strategy, also called theta gang wheel strategy. It capitalizes on the fact that the prices decay over time.
Instead of trying to predict if an asset will go up or down, you play the time game and collect a premium. It turns to profits as time passes, then rinsing and repeating. Options can create an additional income stream in almost any portfolio. Whether you plan to take a position in a stock or own stocks, options strategies, and especially theta gang strategy, can generate income.
The strategies you could use to benefit from theta can be endless. We will focus on the most popular ones that are relatively simple to understand. In this post, we’ll explore the three best options and strategies for generating income. Also, this article assumes you know the basics of puts and calls. This is the minimum requirement for anyone wanting to implement theta gang strategies.
Time Decay On Options: Time Erosion (Theta)
Before diving into income-generating theta gang strategies, it is important to understand the concept of time-value erosion. As well as its effect on the price of options and the income earned.
The erosion of the time value, represented by the theta coefficient, corresponds to the variation of the option’s price according to the time when the other variables are constant. Since options have an expiration date, their value decreases as that date approaches. Theta indicates the rate at which the option price will decline over time and is expressed according to the following relationship:
Theta = Change in option price ÷ Change in time
(when other factors, such as the price of the underlying, are constant)
All income-generating strategies involve selling an option to receive income as credit.
Time value erosion helps the option writer as they earn revenue during the initial trade, and the option’s value decreases throughout its life. Also, the rate at which the option price decreases over time is not linear.
If all other parameters remain constant, the value of short-duration options will decline more rapidly than that of long-term options. Option sellers can make the most of time value erosion by selling short-dated options (weekly options).
Theta Gang Strategies Explained
Theta Gang Strategy #1 – The Wheel Strategy
It makes sense that “The Wheel” is one of the most widely used theta gang tactics available. Some go as far as calling it the best theta gang strategy. Let’s find out why!
The Wheel Options Strategy is also known as the Triple Income Strategy. It is an option play that seeks to make three separate profits from a single stock trade. There are some steps that should be considered when talking about this strategy. They are:
Step 1
The trader auctions cash-secured put options and keeps the premiums on a stock they planned to buy for a long time at a particular price. The premiums result in a 100% profit if the short put options succumb to useless or closed for a gain prior to expiration.
Step 2
In this step, you sell covered calls on the stock when your short put expires in the money. To create a profit opportunity, the buyer will be given the stock if the out-of-the-money call option becomes in-the-money.
This requires selling a call option in the stock with a strike price greater than the initial cost of the stock. At a strike price that you would want to sell the stock for a gain, sell the call. If the price moves sideways, selling covered calls several times for higher premiums can turn the stock into a new way of making money. If the calls are worthless, this will also reduce the stock’s cost basis.
Step 3
The trader profits from the capital and premium profits over the entry price. Either way, the trader is still below the short call option price if the currently owned stock moves up in value, but the covered call stays out.
Step 4
The option play comes to an end in this step. This is when the stock is called away, and the covered call goes into the money and is assigned. All of the short options should result in a profit. When combined with premiums received from selling stock for profit and covered calls, this strategy can produce triple income. If the stock in the Wheel Option Play gained profit while waiting for the covered call, it produces quadruple income.
This options strategy aims to sell the put at a price with little chance of going in-the-money and delegated. If the put option is given, the option trader would buy and keep the stock in a long-term position. If the put option bid out-of-the-money ends in the money, the trader converts it to a covered call strategy.
This reduces the stock’s cost foundation by getting an option premium, regardless of whether the put was initially given.
Theta Gang Strategy #2: Call Credit Spread
The investor sells an out-of-the-money call option and buys more out-of-the-money call options to hedge against a strong upside. In this scenario, the investor profits if the stock stalls, falls, or rises slightly.
The maximum loss becomes limited. The worst-case scenario is known in advance. So there will be no surprises for you in the event of a disaster. If the stock rises and moves above the purchased call option, you will have an unrealized loss.
If this move occurs just after the call credit spread is in place, the loss may be less than the known maximum due to the time value remaining in the options. The maximum gain from a credit spread is also limited and easy to calculate. It’s simply the amount of credit (or the difference of the 2 premiums) received at the start of the transaction.
In the best case, the price action remains below the strike of the call option sold for the entire duration until the day of expiry. Both options expire worthless, and the options are removed from the options trader’s account, and he keeps the premium. Impact of declining time value on credit spread.
Volatility
Like volatility, the effect of the passage of time (measured by theta) can vary depending on where the underlying stock is trading. Since the call credit spread setup we are interested in is initially out of the money, we start with a positive theta.
This means that money is made through the passage of time, all other things being equal.
If the asset trades above the strike price of the purchased call, the position will move to negative theta. Then, the passage of time will hurt the trade.
So, if you ask yourself 2 minutes to think about it, it is quite logical.
If the stock is below the strike of the sold call, we want time to pass because the P&L will slowly move towards the maximum gain.
If the stock exceeds the purchased call option, the trade will approach the maximum loss over time.
Being a bear trade, the delta of a call credit spread will always be negative. This is true no matter what stage of the trade we are in or how it is set up.
Therefore, it is crucial to carefully consider the position of the stock in relation to the strike price when engaging in a call credit spread. If the stock is trading below the strike price of the sold call, it is advantageous for time to pass as it gradually moves towards the maximum gain.
On the other hand, if the stock is trading above the purchased call option, the trade will gradually approach the maximum loss.
Theta Gang Strategy #3: Writing Cash-Covered Put Options
To write a cash-covered put option, you write a put option and set aside the cash needed to buy the stock if the option is exercised. Traders think of this strategy as an equity acquisition and income generation strategy.
The option seller receives the premium from selling the option and can generate an income stream while acquiring shares. For instance, if a stock is trading at $100 and an investor writes a put option on it with a strike price of $95 at an option premium of $1, the investor will be obligated to buy the stock if its price is below $95 at expiration.
It enables the investor to use the income received to reduce the total cost of the shares, which he will buy at the strike price. The actual cost of each action is, in effect, reduced to $94 ($95 – $1).
If the market price rises, the investor benefits from the premium received. If the price falls below the strike price, the investor buys the shares at the price and receives a discount.
Covered call writing means you sell covered calls
It is carried out in two stages. First, you must hold at least 100 shares, then sell an “out-of-the-money” call option.
This income generation strategy best suits a neutral or bearish outlook on the underlying stock. When selling the call option, the investor must sell the stock at the option’s strike price at expiration if this is favourable to the holder ( i.e., the buyer).
The objective of this type of theta gang strategy is for the option to have no value at expiration. This would mean that the underlying price is below the strike price. Thereby retaining the income from the sale of the option.
The seller can repeat covered call writing to generate an income stream. This is until the stock price is above the strike price at expiration. The seller will then have to sell the stock to the buyer of the call option at the strike price.
For instance, if a stock is trading at $100 and an investor writes a call option on that stock with a strike price of $105 at a premium of $1. The investor will be forced to sell the stock if its price exceeds $105 at expiration. If the stock price is below $105 at expiration, the investor will keep the $1 income. It can continue writing covered calls to generate an income stream.
Theta Gang Strategy #4 – Short Iron Condor
In the Iron Condor, traders sell two options and buy two options. The strategy actually combines two vertical spreads – a short vertical put spread and a short vertical call spread. They both expire on the same date.
In both cases, an out-of-the-money option issues another out-of-the-money option for insurance. This strategy makes it possible to anticipate a loss of time value (theta). Note that the erosion of the time value of options written is greater than those purchased as a hedge.
If the underlying value does not exit the fluctuation band of the call and put options, then the premium received equals the profit. The fluctuation band of options written and purchased determines the received premium. The narrower the band, the higher the premium. Indeed, the risk that the price leaves this fluctuation band is higher.
Conclusion
Investors wishing to hold stocks long-term should consider writing cash-covered put options to get the stock at a lower price. Then, write covered call options to generate income once you acquire the stock.
In addition, investors who wish to generate income by speculating on the movement of a stock’s price should consider using credit spreads.
The “Theta Gang” strategy, focusing on collecting premiums through selling options, has attracted attention from both genuine traders and scam artists. Unscrupulous actors might sell “guaranteed” theta-based systems or overhyped courses, preying on novice investors. Always research before committing funds or following purportedly “foolproof” trading strategies.
The key to generating consistent income through these strategies is following a plan based on what works every cycle. Finally, as with all income-generating strategies, short-dated writing options can generate income at an increased rate due to the effects of time-value (theta) erosion.