If you are a trader who operates in Singapore, you may have noticed that options decay at a different rate than in other global markets. This article will explore the reason for this and provide tips on accounting for it when trading. For more information on options trading and how to trade options, you can visit Saxo Singapore.
Table of Contents
The definition of an option
An option is a contract by which you have the right, but not the responsibility, to buy or sell an underlying asset at a set price before or during a given time frame. Options are typically used as a hedging tool to protect against future price movements in assets such as stocks, commodities, or currencies.
What is overnight decay?
In options trading, overnight decay is the loss in value of a position overnight due to theta decay. Theta is the rate of change of an option’s price concerning time. Overnight decay can be a significant factor in options trading, as it can eat into the profits of a position.
To counter this, traders often use rolling-over positions to avoid being impacted by overnight decay. In general, traders should be aware of the potential for overnight decay and take steps to mitigate its impact.
How does this impact the Singaporean market?
The decay rate is typically faster just before options expiration when the time premium on the contract is at its highest. While all options experience some degree of overnight decay, this effect is more pronounced for options with a longer time to expiration.
Understanding how overnight decay works is essential for making sound investment decisions for traders in the Singaporean market.
What strategies can be used to combat decay?
One way to offset the effects of overnight decay is to engage in spread trading. This involves buying and selling options contracts with different expiration dates.
By selling an option with a shorter time to expiration and buying an option with a longer time to expiration, traders can create a position that minimises the impact of time decay.
Another way to mitigate the effects of overnight decay is to use hedging strategies. For example, a trader could buy a put option to offset the risk of holding a long call option.
By understanding how overnight decay works, traders in the Singaporean market can take steps to protect their investments and maximise their profits.
Examples of how decay has impacted traders in the past
There are several examples of how decay has occurred in the past. In 2008, for instance, many options traders were caught off guard by the sudden decline in the value of options as the financial crisis unfolded. As a result, many traders saw their positions decimated by decay. More recently, in 2020, the Covid-19 pandemic caused a sudden drop in equity markets worldwide. This resulted in widespread decay in options positions, leading to heavy losses for many traders.
These examples underscore the importance of understanding decay when trading options. Those who fail to account for it may find themselves at a significant disadvantage.
The importance of staying informed about options decay
When it comes to trading options, time decay is one of the most important factors to keep in mind. Options are time-sensitive contracts, and their value declines as they approach expiration. For this reason, it’s crucial to stay informed about the decay rate so you can make decisions accordingly.
There are a few ways to measure time decay.
The most common is theta, which measures the rate of decline in an option’s value over time. Another way to measure time decay is through vega, which measures how an option’s value changes in response to changes in volatility.
understanding these different measures, you can better anticipate how time decay will affect your options positions and make more informed trading decisions.
At the end of the day
Do options decay overnight in Singapore? While it is generally accepted that option prices do, indeed, decay over time, the speed and extent of this price erosion can vary depending on several factors.
Investors must consider the theoretical and practical implications of option decay before deciding.