Option Trading Blog

In this post I’ll discuss what is known as the theta. Another expression for the theta is time-decay. The effect of the theta on both put options and call options is the same. As each day passes, the option is worth less and less. This should be intuitively clear. As an option gets closer to expiration, the probability that the stock would change it’s direction either way, gets smaller. If the option was out-of-the-money, the probability that it would get into-the-money gets smaller, hence lower value.

The theta of an option is denoted by points loss per day. If the theta is 0.5, the option loses 0.5 points with each day. For this reason it is written as a negative number. This means that long positions on an option will have negative theta, while short positions will have positive theta.

Consider the following graph with a strike price of 60

As you can see, the theta is the largest for at-the-money options. As a good exercise, try to understand the intuition for why this makes sense.

Hint: What happens at the date of expiration?