If you're trading complex options positions, you're likely selling premium in at least some of those positions. You plan to benefit from time decay in those options you've sold.

A recent article discussed one such case, that of a RUT JAN ATM butterfly, with the delta raised a bit by buying one long JAN call. To remind you of the setup, I've included the options that comprised the trade as well as the original expiration profit-and-loss chart.

Original Options Components and Mid Prices at 11:55 AM CT on 12/3/12, via OptionsOracle:

Original Expiration Chart:

On December 3, when this trade was set up, the Greeks were as follows:

Delta: -5.57
Gamma: -0.68
Theta: 22.36
Vega: -122.59

The theta most interests us for the purposes of this article, so that's showing up in bold print. Theta references the decay that can be expected for the passage of each day. If theta is positive for your trade, you benefit from that passage of time. If it's negative, such as when you buy a long put or call position, your profit is hurt by the passage of time. When the butterfly is set up this way, with the RUT between 820-821 on the day the hypothetical trade was initiated, the trade would benefit from the passage of time. Moreover, the closer to expiration, the greater theta would grow.

For example, if the RUT had been at 821 on January 3, unmoved from the price at the opening of the hypothetical trade and if implied volatilities had stayed the same, theta would have theoretically grown to 112.66 according to one charting system's calculations. Time decay would have already produced a hefty profit by that time, and it would have been growing even faster as expiration neared.

But is a positive theta a guaranteed entity for all butterflies over the course of the trade? No way. Let's look at what actually happened to the trade on January 3, imagining that this hypothetical trade hadn't been adjusted in the interim.

Price with Relationship to the Expiration Profit-and-Loss Graph, as of January 3:

The RUT's price has moved well outside the expiration breakeven. Of course, no one would advise letting the price go there without the trader taking some kind of steps to adjust or remove the trade, limiting the loss. That was discussed in the prior article about this trade. Now we want to learn a little more about theta, however, so let's look at the OptionOracle Strategy Summary for the trade to determine what's happened with theta when the price has moved outside the expiration breakeven.

Strategy Summary as of the Close, January 3:

Notice that theta is now negative. Time is no longer your best friend with this trade. Time has turned against you, working to hurt your trade. If you look back at the expiration graph, you can see that the price has extended past the expiration breakeven and is hovering over the valley that shows the deepest potential loss to the upside. The deepest possible loss on the upside measures about $3731.00, according to this site's calculations, and you can see that the $2,236.00 loss has already moved far toward that loss. Each day, even if the RUT were to move no higher, the loss would theoretically grow steeper by $31.08.

The point is that a butterfly is generally a positive theta trade, but that's positive theta as long as the RUT's price is inside or near the expiration breakevens. If the RUT's price moves too far outside that expiration tent, theta turns negative and vega turns positive. These are signs that your trade is in trouble and needs adjustment. The option seller's best friend, theta, has turned against you.

You're thinking that you'd know that the trade was in trouble anyway, without even looking at the Greeks. You'd see the big loss accumulating, and you'd know that the trade was outside the expiration breakeven. However, sometimes we've hedged well enough that losses aren't really all that big before the theta turns negative. Checking butterflies, iron condors and such trades for a negative theta is just one more sign you can use to let you know that you're getting into dangerous territory. It likely means that price is hanging out over a valley that drops below the zero line, and that your loss is going to be deepening as each day goes by. Time to do something about it.

As usual, Jim Bittman's book, Trading Options as a Professional, has something to say about this and about all things Greek. It's not a fun read but is a good resource. Other such books exist, too, but Bittman's is my go-to book for these sorts of things.

And, those of you who are new to Greeks and who perhaps trade only long options may need clarification. Your long calls and puts will always be negative theta unless they're so deep in the money that there's no extrinsic value in them. This article addresses complex positions composed of sold and long options.