Theta Decay | Options Greeks Guide
Theta decay is how much an option price will decline due to time passing. Theta benefits option sellers and hurts option buyers.
Key Takeaways
Theta is one of the key "Greeks" used to measure the sensitivity of an options contract to changes in market conditions.
Theta refers to the rate of time decay of an options contract or the amount by which the options contract's value decreases as it approaches its expiration date.
Theta is influenced by several factors, including the time to expiration of the options contract, the volatility of the underlying asset, and the level of interest rates in the market.
What is Theta Decay?
Theta refers to the rate of decline in an option price due to time passing. Theta decay is also called time decay because, as time passes, options lose value.
Theta is one of the options greeks expressed as a negative number if you buy options and a positive number if you sell options.
Extrinsic Value and Theta Decay
Options are made up of intrinsic and extrinsic values. Time value is another term for the extrinsic value of an option.
At expiration, the only value left in an option contract is intrinsic since there is no time value remaining.
Which Options Have the Highest Theta?
At-the-money (ATM) options are the contracts with a strike price closest to the current spot price.
Far OTM and ITM options have the lowest theta values. Far OTM options have low theta since the premium is generally low, and little value is left to decay.
Far ITM options have low theta values because the intrinsic value is the main driver behind the option's value.
How to View Theta on tastytrade
To view theta values on tastytrade, you must go to the trade tab and open the stock options chain.
At the top of the options chain, next to the bid and ask prices, you can customize your chain to show theta.
All you must do is click one of the metrics, then click theta to add it to the chain.
Strategies to Benefit From Theta Decay
Cash secured put
The cash secured put is an option selling strategy where you write put options. As time passes, put options lose their extrinsic value due to theta decay and benefit the seller.
Covered call
The covered call is an option selling strategy where you write call options on your shares of stock. Short call options benefit from theta decay and are an excellent way to collect premium.
The Wheel Strategy
The wheel strategy combines the cash secured put and covered call.
You sell puts until you are assigned shares of stock, then sell covered calls against your shares until you get called away.
Since the wheel utilizes option selling strategies, they will benefit from theta decay.
FAQ
Is Delta Decay the same as theta Decay?
No, delta decay and theta decay are different concepts in options trading. Delta decay (charm) refers to the change in the delta of an option as it moves closer to expiration. Delta is the measure of how much an option’s price changes when the underlying stock price changes. Theta decay refers to the change in the value of an option due to the passage of time. Theta is the measure of how much an option’s value decreases every day as it approaches expiration.
Who benefits from theta decay?
Theta decay benefits the sellers or writers of options, since they receive a premium upfront for selling the option and want the option to expire worthless or decrease in value. Theta decay hurts the buyers or holders of options, since they pay a premium upfront for buying the option and want the option to increase in value or expire in-the-money.
Does theta decay overnight?
Yes, theta decay occurs overnight, since time passes even when the market is closed. However, theta decay is not constant and may vary depending on other factors such as volatility, interest rates, and dividends. Generally, theta decay accelerates as the option approaches expiration, especially in the last 21 days.
What time of day does theta decay occur?
Theta decay occurs throughout the day, but it is not linear or uniform. Theta decay may be higher or lower at different times of the day depending on market conditions and expectations. For example, theta decay may be higher before a major news event or earnings announcement that could affect the underlying stock price and volatility. Theta decay may also be higher during periods of low liquidity or high demand for options.
What is the theta symbol?
The theta symbol is θ (lowercase) or Θ (uppercase). It is one of the Greek letters that are used to represent various risk measures or sensitivities of options prices. Other common Greek letters used in options trading are delta (Δ), gamma (Γ), vega (ν), and rho (ρ).
What is the formula for theta decay?
There is no simple formula for theta decay, since it depends on various factors such as the type and style of the option, the strike price, the underlying stock price, the time to expiration, the volatility, the interest rate, and the dividend rate. However, one way to estimate theta decay is to use an options pricing model such as the Black-Scholes model or the binomial model. These models use mathematical formulas and assumptions to calculate the theoretical value of an option and its Greeks, including theta. Alternatively, one can use an online options calculator or a trading platform that provides theta values for different options contracts.
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