Theta is a measure of the rate of decline in the value of an option due to the passage of time. It can also be referred to as the time decay on the value of an option. If everything is held constant, the option loses value as time moves closer to the maturity of the option. It is part of the group of measures known as the Greeks , other measures include delta , gamma and vega , which are used in options pricing.
The measure of theta quantifies the risk that time imposes on options as options are only exercisable for a certain period of time. Time has importance for option traders on a conceptual level more than a practical one, so theta is not often used by traders in formulating the value of an option. The Greeks measures the sensitivity of options prices in relation to their respective variables.
The vega indicates how an option's price theoretically changes for each one percentage point move in implied volatility. If all else remains equal, the time decay causes an option to lose its value as it approaches its expiration date. Therefore, theta is one of the main Greeks that option buyers should worry about since time is working against long option holders.
Conversely, time decay is favorable to an investor who writes options. Option writers benefit from time decay because the options that were written become less valuable as the time to expiration approaches. Consequently, it is cheaper for option writers to buy back the options to close out the short position.
This is unfavorable to the option holder. Dictionary Term Of The Day. Broker Reviews Find the best broker for your trading or investing needs See Reviews.
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