One of the quickest ways to lose lots of money, when trading options, is to completely ignore the fact of time decay on options. If you are fairly new to options what I am about to explain can help save you money by not letting you learn the hard way. Time decay cannot be ignored when trading options. If not ignored it can be very beneficial to you, if you forget about it, I guarantee it will hurt.

There are three concepts you must understand about options in order to understand time decay. First you must understand that a premium is what you pay to give you the right to buy or sell an option. You want to keep this amount as close to the intrinsic value of your option as possible to help minimize your risks. For instance if a stock is selling on the open market for $12 and you have a call option to purchase the stock for $11 then you don't necessarily want to pay a high premium, depending on the amount of time.

For example if you pay a premium of say $4 for the right to buy for $11 then the total cost to you, if you were to exercise the option, would be $15. This means, that this option would have $1 of intrinsic value and $3 of time value. The closer to the time that your option expires, the more time value you lose. If the price remains the same and doesn't move within the time frame of the contract then you could lose the full $3 of time value. And remember these contracts are purchased in 100 share lots.

You really have to consider the stock you are picking. The above deal might still be good, depending on the stock and your ability to afford the risk. You must keep in mind that you will lose the time value in every option. Time to expiration will always decrease; it is one of the golden rules to options. You need to take into consideration what part of your premium is time value and if you have any intrinsic value when trading options, because time value is subject to decay.

It is easy to keep track of these numbers if you pay attention to the Greeks. The Theta in your options brokers' platform tracks the time decay for you. This comes in really handy when you are putting on multiple positions. I would highly recommend that if you are just starting out with options that you learn the Greeks, and what they mean.

For the purposes of this article just remember that all options are subject to time decay. Remember that not all time decay is bad. In fact it can be quite beneficial if you are the one selling the option. If the option expires without being exercised you get to keep the premium and the stock. If you are purchasing an option try to keep the amount of time value as low as possible to increase your odds of the option being in the money enough to make you a profit.

For more information on trading options basics, you can sign up for this free video basics course on trading options.

DISCLAIMER: No personal investing advice is implied or stated in any video or written presentation. The information presented is for educational purposes only and should not be construed as personal legal or investment advice.