Interesting trading points raised by Brian:
I have been trading front month ICs (opening 4-6 weeks out), but at times am finding it too challenging to manage. So in Sept I experimented by opening a Dec position (3 months out). One thing I noticed is that the theta decay was almost non-existent the first 30 or so days. I could have opened the position 30 days later for almost the same credit. Not sure if this is a usual occurrence or not.
Also am curious as to why you say that SPX is difficult to trade. I would think that RUT would be more volatile and hence more difficult. (it seems to rise & fall more, %-wise, than SPX)
1) 3-month options have time decay. And I know that you know that to be true. It is not anywhere near zero, nor should it appear to be near zero.
Here's one way to see that for yourself. When you look at a 3-month trade (even if it is not a trade you make in real life), also look at the 2-month trade with the same strikes. Then you can compare just how much more time premium is built into options with a 4- or 5-week longer lifetime. That should provide a reasonable estimate for how much time decay to anticipate over the next month or so.
Be careful to keep an eye on the implied volatility (IV) for the underlying: VIX (for SPX options) or RVX (for RUT options). Longer-term options are more vega dependent, and if IV rises, you may see what appears to be zero time decay. It's not. It's just what can happen when vega affects the option price by more than theta.
We have all seen examples in = which a sudden market decline, accompanied by a surge in IV . The result is a huge increase in the value of put options and even an increase in the price of call options as the market falls. That's vega trumping theta, delta, and gamma simultaneously.
2) It's the negative gamma that makes spreads challenging to manage efficiently. Longer-term options have less gamma. This may seem simplistic, but the truth is that when trading those 3-month options, you earn your profits more slowly (less theta). In return, larger market moves result in less change in the price of individual options and option spreads – and less money is lost.
If you want maximum risk and maximum reward, then you found it with front-month options. If you prefer less risk and less reward, you can move out in time and initiate trades using 3-month options. Then if you also plan to exit early – two to four weeks before the options expire – you avoid the period of maximum time decay and maximum effect of negative gamma.
I know it's difficult to leave money on the table, but you are not really doing that. From my perspective, early exit means taking a decent profit – or perhaps a loss if you made an unfortunate adjustment or two earlier) – but the main benefit is eliminating all risk and being able to sell new, longer-term options with less risk.
This philosophy is not for everyone, as short-term options constantly get the most play. If not convinced that this is true, the high volume of Weeklys ought to make it obvious that short-term options (when do the Dailys start trading?) are the favorite tools of most traders (and all gamblers).
3) I used 'difficult' to trade SPX in the context that it is more difficult to buy/sell the options at favorable prices. The markets are wider, there are no exchanges making competitive quotes, and the last time I tried to trade these (a few years ago), they did not even have electronic trading.
I was not referring to managing the position. Yes, RUT is a more volatile index, presenting more management challenges. However, option premium is higher, and that means the trader is compensated for taking additional risk.