$116 Million Per Day In Option Time Decay

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 |  Includes: AAPL, BAC, BIDU, CF, CSCO, EEM, SPY, XLF, YHOO
by: Mike Scanlin

There are 3410 stocks and 271 ETFs that have call options expiring next Saturday, February 18, 2012. The total amount of open interest in those call options is 27.6M contracts. The sum of the time premium portion of those contracts is $582 million. With only 5 trading days remaining, if all 27.6M contracts were held to expiration, call option sellers would generate about $116M per day in time premium capture.

Intrinsic Value vs. Time premium

An option's price is made up of two components: Intrinsic value and Extrinsic value (commonly known as "time premium"). The intrinsic value is the amount the option is already in-the-money (current stock price minus the option's strike price), and the time premium is anything that is left over. For out-of-the-money options the intrinsic value is zero and all of the option's price is time premium.

In-the-money example: If XYZ stock has a current price of $48/share, and if a Feb 18 expiration call option with a strike of $45 is selling for $3.50 then:

intrinsic value = 48 (stock price) - 45 (strike price) = 3
time premium = 3.50 (option price) - 3 (intrinsic value) = 0.50

Out-of-the-money example: XYZ stock at $48/share, and a Feb 18 expiration call option with strike of $50 sells for $0.35:

intrinsic value = 0 (since stock price > strike price)
time premium = 0.35 (option price) - 0 (intrinsic value) = 0.35

In both cases, as time passes the time premium falls (assuming underlying stock price and volatility are constant), reaching zero on option expiration day. This time decay accelerates as the number of days until expiration falls:
Option Time Decay

Time premium is the source of income for investors who write (sell) covered call options. In their perfect world the underlying stock remains flat (unchanged) between the time they write the option and its expiration. If that were to happen they would neither make nor lose money on the underlying stock, and they would count all of the time premium as income during that period.

Of course in the real world stocks do not stay flat for very long, and there is significant risk that the stocks will drop before expiration. If they fall far enough then the covered call writer will lose more on the stock portion of the trade than he's made on collecting time premium for the trade. The odds of this situation can be reduced by selling in-the-money (or deep in-the-money) calls but (1) that's still not a guarantee against losses, and (2) the returns are much lower as the strike gets deeper in-the-money.

Time Premium For Feb 18 options

The top 10 call option series (measured by open interest) for the Feb 18 expiration are:

Symbol Stock
Price
Call
Strike
Time
Premium
Open
Interest
XLF 14.59 14 0.01 287,703
SPY 134.50 126 0.05 174,843
BAC 8.08 8 0.15 166,523
XLF 14.59 15 0.04 163,851
SPY 134.50 135 0.92 147,154
BAC 8.08 7 0.02 146,995
CSCO 19.93 21 0.03 137,821
SPY 134.50 136 0.49 133,422
YHOO 16.07 16 0.26 132,938
EEM 42.98 45 0.05 131,459
Click to enlarge

The top 10 measured by the amount of time premium remaining in the series (open interest * time premium) are:

Symbol Stock
Price
Call
Strike
Time
Premium
Total Time
Premium
SPX 1343.64 1350 6.60 $34.8M
SPX 1343.64 1340 8.56 $18.6M
SPY 134.50 135 0.92 $13.5M
SPY 134.50 135 1.03 $11.2M
NDX 2547.32 2550 20.80 $11.1M
SPX 1343.64 1325 3.06 $11.0M
SPY 134.50 133 0.68 $8.9M
SPX 1343.64 1345 9.40 $7.6M
NDX 2547.32 2575 9.60 $7.2M
SPX 1343.64 1360 3.70 $7.1M
Click to enlarge

If we ignore indexes and ETFs, the top 10 option series measured by amount of time premium remaining before the Feb 18 expiration are:

Symbol Stock
Price
Call
Strike
Time
Premium
Total Time
Premium
AAPL 493.87 490 4.93 $6.2M
AAPL 493.87 500 4.30 $5.9M
BIDU 136.72 135 4.53 $4.3M
AAPL 493.87 495 6.25 $4.1M
BIDU 136.72 140 4.00 $3.6M
YHOO 16.07 16 0.26 $3.5M
CF 180.99 190 2.47 $2.7M
BIDU 136.72 130 2.53 $2.7M
AAPL 493.87 480 1.73 $2.5M
BAC 8.08 8 0.15 $2.5M
Click to enlarge

These are not trade recommendations, but they do show you where the big money is trading. AAPL is on the list because of its large market cap and the fact that it made new highs last week, while BIDU and CF are probably on the list because they both have earnings this week.

Oh, and for those of you interested in the March 17 expiration, there is currently $2.7 billion of time premium in the 26.1M March 17 call options that have been sold, or about $75M per day in potential time decay.

Disclosure: I am long AAPL.