What is Theta in Options Trading?
Theta is one of the Greeks in options trading. Generally speaking, theta represents the time value of options.
There are five Greeks in total - Theta, Vega, Delta, Gamma, and Rho.
In theory, theta is how much your option will decay for one day until it expires. In other words, it is time decay per day.
For example, if you have a one month option selling at-the-money and it is trading for a dollar. Theta could be -0.10, which basically means theta is -10 cents.
In theory, if one day goes by and all other options Greeks are held constant, the option should be trading at 0.90 cents. However, this is only in theory and in practice, the other variables will come into play. We will discuss those variables in other Pro Options Trading Tips.
The further out from the options expiration you are, the less expensive time value will be.
Meaning we will be paying less for the time value of the option. For example, if you have a option that expires in 3 months versus one that expires in 1 month, the time value on the 3 months will be cheaper than the time value on the 1 month.
As a 3 month option becomes a 2 month, the time value decays at an accelerated pace.
This means a bigger portion of your options value will decrease as a gets closer to expiration. For example, a three month option may have a theta of -.02 whereas a two month options may have a theta of -.05.
Labels: Pro Options Trading Tips