This would be a great time to tell you exactly what option trading is really all about.  Option trading is about cost and compensation for changing levels risk.  When speaking about cost and compensation for risk, there are three primary variables that apply. The first is movement in the underlying asset price (e.g., XYZ's stock price).  The second is time decay.  The third is implied volatility.

It is useful to think of movement in the underlying asset price as the primary source of risk, and to think of time decay and implied volatility as producing the cost or compensation for changes in that risk.  We can refer to the risk posed by movement in XYZ's stock price in two separate terms: realized and expected.

• Realized Risk is profit or loss to the trade that has already resulted, and that is due strictly to movement in XYZ's stock price.



• Expected Risk refers to the impact to your trade if XYZ's stock price changes by a given amount.

An option trader is continuously compensated (or charged) as the stock’s risk to his option trade changes. There is cost and compensation for both realized risk and expected risk.

• Cost and Compensation for Realized Risk (i.e., Time Decay P&L): You will either pay, or be paid, to sit there and realize risk over time. For example, you may have been paid $40 to hold an option position for a day. And during that day, XYZ stock may have moved in such a way that it produced a $35 loss. So you were paid $40 to realize a $35 loss caused by the stock’s movement, for a net of $5.



• Cost and Compensation for changes in Expected Risk (i.e., Implied Volatility P&L): In this case, you either pay, or get paid, for changes in expected (i.e., upcoming) risk.  Expected risk tells us what the potential realized risk could be. We can then compare our cost or compensation for changes in expected risk to the potential impact to our trade.