Theta Decay describes the loss in value of an options contract over time, other factors being equal.
Theta enables option traders to know how much value an option can lose per day because of the passing of time.
Theta Decay describes the loss in value of an options contract over time, other factors being equal. It's a time decay measure - the closer an option is to expiring, the quicker it loses value.
Theta enables option traders to know how much value an option can lose per day because of the passing of time. It's imperative for:
Options pricing and strategy
Risk and expectation management
Planning entry and exit points in trades
All options have an expiry date.
As this date approaches, the time value of the option decreases.
Theta measures this decrease, usually as a negative number.
Example
If an option has a Theta of -0.05, it will decrease by ₹5 per day (in Indian markets, each option contract usually represents 100 shares) just because time is passing.
Option buyers are damaged by theta decay, particularly when the price does not move their way soon.
Option sellers (writers) profit from theta since the value of the options they sold loses value with time - perhaps enabling them to repurchase them at a lower price or allow them to expire worthless.
Time decay is gradual initially, but picks up in the final 30 days leading up to expiry.
At-the-money options depreciate most quickly, but deep in- or out-of-the-money options are less susceptible.
For Option Buyers:
For Option Sellers: