Value vs. stock price, at several dates
The dotted hockey stick is intrinsic value: what the option is worth at expiration, the amount it's in the money. Any price above that is time value, the market's payment for the chance the stock still moves your way.
Time value is largest right at the strike, where the outcome is least certain. As days run out, the curve sags down onto the hockey stick.
Value vs. days remaining (theta decay)
Time runs left to right toward expiration, with the stock price and IV held fixed. Decay is not linear: time value scales roughly with the square root of time left, so an at-the-money option loses as much in its last ~11 days as in the ~34 days before that.
Out-of-the-money options decay to $0. In-the-money options decay only down to their intrinsic value.
Value vs. implied volatility (vega)
Higher IV means the market expects bigger swings, so every option (call or put) costs more. For at-the-money options the relationship is nearly a straight line.
This is where IV crush comes from: IV is high before earnings and drops right after, so an option can lose value the morning after even if the stock moved in your direction. Out-of-the-money options are nearly worthless at low IV and gain the most, in percentage terms, when IV rises.
Delta vs. stock price: how fast the option moves
Delta is the slope of Fig. 1: dollars of option value per $1 of stock move. A delta of 0.50 means the option moves about half as much as the stock. Traders also read delta as a rough probability of finishing in the money.
Close to expiration, delta becomes a step at the strike. Small stock moves near the strike then swing the option hard. That steepness is gamma, and it's why short-dated options near the strike are so volatile.
Annualized premium yield vs. days to expiration
Premium collected divided by the capital tied up (the stock for a covered call, the strike × 100 in cash for a secured put), scaled to a year. Same stock price and IV, only the expiration changes.
Short expirations pay more per day because of the square-root decay in Fig. 2. They also put you on the steep part of Fig. 4, where a small stock move can flip the trade from comfortably out of the money to assigned.
When to sell, and when to close
Selling either one is selling insurance. Sell it when people are overpaying for it: right after a sharp move, with implied vol high for that stock, and at a strike where you'd actually be glad to buy or sell the shares.
Sell a covered call when
Don't sell when
For both
- 30–60 days to expiry is the sweet spot for time decay. Decay is still gentle and gamma is low. Weeklies pay more per day (Fig. 5) but turn every news item into an assignment risk. Fig. 2, 4, 5
- Buy back at 50–75% of the premium captured. Don't hold for the last few cents: the premium left is small while gamma keeps growing. Fig. 2
- Buy back calls after the stock drops, and buy back puts after it rallies, then sell again on the next swing.
- Collateral is always fully cash-secured, never on margin.
- Before you sell, check the whole book. It should still fit its limits if every open position is assigned at once.
Reading the numbers
- "IV high for that stock" means IV rank above about 50 (where today's IV sits in the stock's own 1-year range; brokers show it) and IV above the last 20 days of realized vol. Compare a stock with its own history, not with other stocks. Premium rises almost linearly with IV. Fig. 3
- Know why IV is high. It runs up before earnings and similar events because a big gap is likely, then collapses afterward (see the "IV −10" row). Holding through the event only pays if the stock stays inside the expected move.
- Delta tells you the odds. Delta is roughly the chance the option finishes in the money; 0.15–0.30 is the common range for short options. Fig. 4
- Covered calls: watch the ex-dividend date. An in-the-money call is likely to be exercised early the day before ex-dividend if its remaining time value is less than the dividend. You lose the shares and the dividend.
- Buying instead of selling? Flip the rules. Buy when IV is low relative to its history, buy more time than you think you need, and expect to need a move bigger than what IV already prices in.
Should you sell a covered call? Start with your view on the stock
| Your view | Covered call? |
|---|
A covered call and a cash-secured put at the same strike and expiration have nearly the same payoff: you keep the premium, give up the upside above the strike, and keep the full downside below breakeven. Timing the entry well helps at the margin. The main driver of your result is still what the stock does.