Market Overview

How Option Time Decay (Theta) Works


What is Theta? What is option time decay? How does time decay work? These are common questions of beginning options traders.

Theta is the Greek term used to denote option time decay. Theta is one of the 'Greeks' used by options traders for option analysis. Theta measures the rate of decline in the value of an option due to the passage of time.

Options are wasting assets. Options lose time value (decay) every day until expiration. Once expirartion is reached time value becomes equal to 0. The longer the time to expiration the more expensive the option will be.

The rate of option time decay (Theta) increases with about 30 days until expiration for out of the money (OTM) options. Why? Because being closer to expiration increases the probability of accurately forecasting the direction and price of the stock or index.

Option values, or premiums, for out of the money options are made up entirely of Theta, or time value. When selling options, the closer to expiration you are the better the better your odds. On the other hand, the closer to expiration you are the smaller the premiums are.

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The further away from expiration you are the greater the premium there is to sell. When selling longer term options you want to sell with about 40 or more days until expiration.

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Selling options is a far better strategy then buying options. Unless you are able to predict with extreme accuracy exactly WHEN and HOW FAR a stock or index will move then selling options is definitely the best approach.

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The following article is from one of our external contributors. It does not represent the opinion of Benzinga and has not been edited.


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