Many of us who trade complex options positions can testify, after this last couple of months, that timing can be everything in these trades. As I mentioned in a recent article, I was privy to the trading experiences of many who entered February butterflies on January 19, as I did, and some who entered on January 20, just a day later. Among those who shared their experiences, few who entered on January 19 were able to rescue their butterflies without losses. That was true of some who employed expert and timely adjustments. Many who entered just a day later were able to capture gains.

When paging through Jeff Augen's The Option Trader's Workbook the other day, I happened on a happier discussion of timing. Timing is everything in less complex options positions, too, his discussion reminded me. He asked readers to imagine a situation in which a three-standard deviation move delivered a profit on a trade. Would you be more likely to exit that now-profitable trade and lock in profit if that three-standard-deviation move had occurred early in the option-expiration cycle or closer to expiration?

If you're wise, Augen counsels, you'll immediately exit at least enough contracts to pay for the original trade whenever it occurred. The closer that big moves occurs to option expiration, the wiser it would be to exit an even larger proportion of the original trade, he adds. Why does the timing matter? A profit is a profit, right? A three-standard deviation move is just as unexpected early in the option expiration period as it is late in an option-expiration period, isn't it?

That might be true, but that's not necessarily all that we should be considering. In order to understand the importance of Augen's admonition, we have to look at two factors, option value decay into expiration and the rarity of a three-standard deviation move.

Augen gave some examples of an option's price when he was asking readers to imagine this situation. He didn't specific whether the option was in-, at-, or out-of-the-money, however. The example seems to suggest that the option was either at or slightly in the money. The following graph showing how at-the-money options decay into expiration comes from James B. Bittman's Trading Options as a Professional (63). This book is a bit dry, to say the least, but it's a great resource for options' traders.

Theoretical Price versus Time to Expiration of an At-The-Money Option:

As the graph shows, the theoretical price of an at-the-money option drops off sharply as expiration approaches. The theta-related decay starts working exponentially on the extrinsic value--the time value--in a particular option.

Augen's example was pricing an option with a current value of $3.75, an option that was originally purchased for $2.50 some days earlier. At the time this article was roughed out, on Mar 8, INTC had closed at $20.77 and its MAR 17 call was $3.73, so fairly close to the value Augen had mentioned. The following OptionsOracle chart graphs profit/loss versus option expiration for this option, giving us the profit or loss we could expect for that option if INTC were to sit at $20.77 into the MAR option expiration. Of course, we know by now that INTC did not do this, but neither had INTC just experienced a three-standard-deviation move. The purpose was to show how decay would have worked if INTC had stayed static at the MAR 8 price.

Theoretical Profit/Loss From the Current $3.73 Price as Expiration Approaches, If Price Stays the Same:

The vertical axis depicts the loss from the then-current $3.73 price. The legend along the bottom did not translate, but that legend shows a theoretical loss--if INTC's price had stayed static--by the end of the day of March 11, located at the red dot, at $0.33 per contract. That's about 9 percent of the option's price after the supposed three-standard deviation move.

How likely is it that there will be another three-standard-deviation move in the right direction? First, we ought to consider what the likelihood of a three-standard-deviation move on any one day might be, before we decide whether it would be likely to occur again soon. Theoretically, the likelihood of a three-standard-deviation move on any one day is less than 1 percent. Some would argue that the stock market prices don't actually follow the standard bell curve distribution but in fact have something called "fat tails." This means that prices tend to move toward the outer boundaries of that bell curve more often than would be expected, fattening that tail instead of flattening them the way we expect a bell curve distribution to look. In other words, unexpected moves perhaps occur more often than the standard bell curve would predict them.

Fat tail or not, though, that's a big move. If the move has been to the upside, we usually expect the old "small-range days tend to follow big-range days" pattern to reassert itself in the most bullish of scenarios. In less immediately bullish scenarios, we can expect a retreat, a reversion to the mean. For example, as I'm editing this, I'm noticing that the SPX on Friday again reached down to test its 10-sma, a moving average that the SPX tends to reach down to touch every week or two, even during a strong rally. It had pulled far away from that moving average earlier in March, and now it's come down to test it twice in one week, starting to flatten it. When the SPX pulled back to test it on Monday, March 22, this was a kind of a reversion to expected behavior after a sharp climb.

Of course, theoretical values, the probability of a three-standard-deviation move, "small-range days tend to follow big-range days" truisms, or even observations about the SPX's old pattern and the tendency to expect it to revert to that pattern are all just theoretical possibilities. Stock indices and equities could zoom right into option expiration and the lucky person who held Augen's imagined profitable positions after a three-standard-deviation move could have seen prices double.

Or half.

Sometimes, trading isn't about being exactly right all the time, but rather about thinking about the possibility and probabilities. If one has a hefty profit ($3.37 current price - $2.50 original purchase price) a few days before expiration, with that profit produced by an out-of-the-ordinary move, there's a hefty chance that the profit in hand will be the largest that option contract will produce. Augen wants you to think about, at the least, selling enough of the position in these circumstances to pay for the original debit, so that there's no possibility of a loss.

In fact, Augen suggests that if the big, out-of-the-ordinary move that delivers that profit occurs at the open one day close to expiration, you exit immediately, at the open.

Again, there's no right or wrong. The moment you decide this advice sounds good and decide that you'll adopt Augen's suggestions the next time you're sitting on a profit when a big move happens close to expiration, that early morning move will be followed by an unbelievable move in the right direction and you'll be singing the shoulda-woulda-coulda song. I wish there were promises, but there aren't.