wrote a 3M article from March 11th 2012 when it was trading at around 86.60 and looked like it had just hit the last leg of a bullish climb that started in October of 2011. I perceived weakness in the RSI. So I thought the stock would consolidate. Analysts were not bullish on it, as they continued to hide in the "hold" zone. I never was bearish on the stock, just believed that it would enter a time of consolidation. Often, when a stock consolidates, it retreats. This is not always true, sometimes it remains in a neutral zone, but I thought it might retreat after the move up.
Here is where it is important to make a decision on how much time your trade needs. I expected a consolidation period and I chose to initiate a bear put spread to capture a profit on a temporary downside move but I did not know when it would happen. Would it happen in a month? If I thought so I could have bought April monthly options. I did not know when it would go down. This is where an option trader needs to make a decision on how to protect one's self against the adversary of a debit spread -- the evil Mr. Time Decay!
I am kidding about the "evil" to a point. Time decay is helpful when it is profitable and harmful when it is losing money. In the trade I made, I am incurring a net debit. The stock must move down for me to make a profit. Considering I did not know when the stock would move down, I need to give myself enough time to be right. The closer one initiates a trade like this to expiration, the more time decay can work against you if the trade is not going in your direction. For this reason it is important to give yourself enough time to be right like I stated earlier. I cannot state that enough-
Trade this strategy over longer periods to give yourself enough time to be right.
If the position of one's trade remains unprofitable, time decay will work against you especially the nearer you get to expiration.
(Click to enlarge)
Looking at the trade I did on 3M back in March, the stock has been moving up and down in a peak and valley pattern with a bearish flavor to it. There was one time it touched below the 82.5 mark that would get me to sell, but I help off hoping it would go down more. Missing that opportunity, I still have time though so it wasn't that bad.
It is mid June now and my options do not decay until October, so I still have four months of time to see if the stock moves down. This extra time is important. One other point I should make as we look at the 3M chart, if you notice how the stock moves in that bearish "peak & valley" formation, this usually prolongs a downward move because of the sizeable but slow up and down movement. This can take place sometimes for a week or more one way. If it moves like this, it may take months to reach the lower point and time decay protection is important.
Since I bought this trade clear out to October, it gave me seven months of protection to make a decision on what to do with the trade. I still have time before I need to reverse the trade at some point and take a loss if it does not pan out. But this trade I made with 3M is a good example of the importance of strategically deciding the protection one needs for time decay. I have read that three to six months is a good average to consider.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
