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What is Options Theta? Time Decay in Financial Options
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What is Options Theta?
An option's theta is a measurement of the option's time decay. The theta measures the rate at which options lose their value as the expiration date draws nearer. Theta is generally expressed as a negative number, the theta of an option reflects the amount by which the option's value will decrease every day.
An Example
A call option with a current price of $2 and a theta of -0.05 will experience a drop in price of $0.05 per day. So in two days' time, the price of the option should fall to $1.90.
Time to Expiration and its Effects on Theta
Longer term options have theta of almost 0 as they do not lose value on a daily basis. Theta is higher for shorter term options, especially at-the-money options. This is pretty obvious as such options have the highest time value and thus have more premium to lose each day.
Conversely, theta goes up dramatically as options near expiration as time decay is at its greatest during that period.
Changes in Volatility and its Effects on Theta
In general, options of high volatility stocks have higher theta than low volatility stocks. This is because the time value premium on these options are higher and so they have more to lose per day.
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