Options Trading Mastery: Time Decay and Volatility Trading Opportunities

When vertical spreads are mentioned, they quite often come with monikers such as 'bull' and 'bear'.

This lends most to think of vertical spreads as directional plays which is true.

However, vertical spreads can be used to take advantage of two other potential trading opportunities - time decay and volatility movement.

If you are looking for a fully hedged way to take advantage of time decay, a vertical spread can be an excellent tool.

Knowing a little about them now, you will recall that a vertical spread has a limited profit potential but also a limited loss scenario for both the buyer and the seller.

So, how do we use this covered trade to take advantage of time decay

At-the-money options have more extrinsic value than their similar month in-the-money or out-of-the-money options.


Since it is an option's extrinsic value that decays away over time, you could set up a vertical spread by selling an at-the-money option and buying either the out-of-the-money option (creating a credit spread) or buying an in-the-money option (creating a debit spread).


If the stock holds tight to the out-of-the-money option, the option's extrinsic value will decay away at a faster rate than either the in-the-money option or the out-of-the-money option due to the fact that the at-the-money option has more total extrinsic value to decay in the same amount of time as the others.