Options Theta: Does Time Matter in Options Trading?
Options theta, the 4th Options Greek tells you how much an option lose its value over time.
This is a double edge sword as it helps you as an options seller but kills you as an options buyer or owner. Options theta is negative for long position (buyer) and positive for short position (seller).
The value of an option is made up by 2 parts: Intrinsic (real) value and Time value.
Intrinsic value exists in an option when the strike price is below stock for calls and above stock for puts.
For example, if IBM 20 Call options purchased at the time its stock is trading at $25, it has $5 intrinsic value.
In this example, if IBM 20 call prices at $6.00 then you would have only $1 in time value. Simple math hey, right?
Time value decays away over time but its rate of change varies depending on how much time left the option has.
If it has 90days, Theta is small but a 40days option will have greater amount to decay. It is greatest in the last 30days where it just looks like falling off the cliff.
To blow your head off, I will give you a math formula so you can manually calculate your options theta. JWell, it is actually not too hard.
Theta = time value of an option divided by the amount of days left until expiration.
For example, at the time of this writing, EBAY was trading at $19.26. That would make the EBAY Jun 20 call (12 days to expiration) an OTM option and its value ($.27) is totally time value.
Options Theta of this option is .27/12 = -0.01.
This means that this option will lose $0.01 per option the following day. This will be recalculated greater towards $.27 at the end of its life – final expiration moment.
Since options theta is the greatest, it decays the fastest in the last 30 days; thus sell options with 30 days to expiration.
Category: OPTIONS GREEKS
