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Options Indicators (the Greeks): Theta


Theta provides an indication of the sensitivity of an option's fair value to small changes in the time left to expiration. Theta is often expressed as the amount an option's price will decay in a single day. Theta thus provides an estimate of how much an option's theoretical value decreases when one day passes – assuming there is no move in the stock price and no change in the option's implied volatility.

Theta is used to estimate how much of an option's extrinsic (i.e., time) value is whittled away by the constant passage of time. Because an option loses time value as time passes, theta is shown as a negative number. Time decay works against option buyers but works in favor of option sellers (writers).

  • For Long calls and long puts: Theta is always negative;
  • For Short calls and short puts: Theta is always positive;
  • For Stock: Theta is zero, because a stock's value is not eroded by time;
  • For options with fewer days left to expiration: Theta has a much greater impact later in the life of an option, i.e., when it gets closer to expiration. Note that time decay is not a linear function; it accelerates as the option approaches expiry.

Theta decreases as options go in- or out-of-the money; it is highest for at-the-money options. It also increases when implied volatility goes down or when fewer days remain to expiration. A position that consists of long options with a high, positive gamma value also has the highest negative theta. Long gamma provides the fuel for an option position to make money if the underlying starts to move substantially (think of a long straddle); however, the price you pay for all that power is theta. Theta will increasingly start to hurt your long position the longer a stock remains (more or less) stationary, and the longer you hold the position.

Theta is not the same for a call and a corresponding put at the same strike price and with the same expiration date: There is a difference which is accounted for by the cost of carry for the underlying stock. When the cost of carry for the stock is positive (i.e., when its dividend yield is less than the interest rate), the call's theta will be higher than that of the put. Conversely, a call's theta will be lower than that of its corresponding put when the cost of carry for the stock is negative (i.e., when its dividend yield is greater than the interest rate).

The fact that options are decaying assets is a vital trading lesson that needs to be fully understood; it is particularly relevant for those just starting out in options trading. As noted above, an option's time decay is not linear: Theta accelerates faster and faster the closer an option gets to expiration. Some traders thus liquidate or roll out their positions when one month or less remains to expiration.

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The Information on the Site is provided for information purposes only. The Information is not intended to be and does not constitute financial advice or any other advice. The trading of stocks, futures, commodities, index futures or any other securities has potential rewards, and it also has potential risks involved. Trading may not be suitable for all users of this Website. Past performance is not necessarily an indication of future performance. You absolutely must make your own decisions before acting on any information obtained from this Website.

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