What Is “Theta” In Options?
When you are BUYING options, time decay in options can suck the life out of you.
But when you are SELLING options, you should forget everything you learned about time decay, because now suddenly THETA is your best friend!
In this article, I’ll show you 3 amazing facts about time decay in options.
Let’s review: In a recent video, I talked about Option Premium. And we talked about “real value” and “time value.”
If you need a refresher on this concept, check out this short video I did on “option premium”: https://youtu.be/vNgixh2PDFM
In a nutshell:
If an option is out of the money, then there’s no “real value” in this option, and the premium you see on your trading platform is only TIME value.
So let’s take a look at a very specific example. THIS is a trade that I currently have in my account: SPCE.
Right now, the stock is trading at 17.71.
So let’s talk about the PUT option that I traded:
A PUT option means that you are allowed to SELL the stock at a certain strike price.
I traded the 13 PUT, which means that somebody who owns the put option is allowed to sell it at $13.00:
Right now, the price of SPCE is at 17.71. So why would anybody exercise the option and sell the stock for $13, if you can sell it right now for more than $4.5 higher at 17.71?
It doesn’t make sense, right? So there’s no “real value” in this option UNLESS the price drops below $13.
This means, that the price the option is trading for right now is only “time value.” (see the video on options premium: https://youtu.be/vNgixh2PDFM)
So let’s take a look at the option price right now:
The 13 PUT Option with an expiration of May 8 is trading at $0.35 x $0.37, so let’s use the midpoint: $0.36.
Options are trading in “100 packs,” so this means that there’s $36 in time value in this option.
What Is “Theta” In Options?
Theta shows you how much the option loses in time value per day.
As you can see in the image above, right now, the Theta of the 13 Put for May 8 is 4.6 cents.
And since options are trading in 100 packs, this translates into a so-called “time decay” of $4.60 per day.
Here are 3 Amazing Facts About Time Decay In Options
Fact 1: It’s the ONLY thing that’s guaranteed:
Every day, the time value of an option is getting smaller.
This is also called “time decay in options.”
As you know, usually there’s NOTHING guaranteed when it comes to trading, but time decay is!
This is GREAT when we’re selling options, and that’s what I like to do right now – since the markets are still crazy!
Fact 2: The sooner the option expires, the higher the time decay!
The “theta” of the 13 Put that expires on May 8th with 11 days to expiration is 4.6 cents.
Take a look at this:
The theta of the 13 Put that expires on May 15th with 18 days to expiration is only 4 cents.
And the Theta of the 13 Put that expires on June 19th with 53 days to expiration is only 2.5 cents.
This is important, because here’s what this means:
- If you are an options BUYER, then time decay is your enemy! So as a buyer, you want to choose MORE days to expiration so that Time Decay doesn’t hit you.
- If you are an options SELLER, then time decay is your friend! So as a seller, you want to choose as few days to expiration as possible.
Fact 3: Since time decay decreases every day, you can make money even if the stock does NOT do what you want!
Let’s talk about my trade:
I was SELLING the 13 Put. This means that I want the stock price to stay ABOVE 13. Ideally, I want the stock price to go up.
I sold this Put Option on April 20th, when the stock price was at $19.0.
And now it is trading at $17.71. This means that SPCE dropped almost 7%!
But here’s what happened: I sold this option for $0.58.
And right now, one week later, it’s trading at $0.36.
That’s a profit of $22 per option.
And since I traded 25 options, that a profit of $550:
So even though the stock did NOT do what it was supposed to do, I still made money.
SPCE was supposed to go up, but it went down by 7%, and I still made $550.
That’s why I love selling options during times of high volatility 🙂
Now you understand was theta in options is and how time decay in options work.
I was wondering how do you select an option that is fairly far out of the money? What Theta would you use to get a cheaper option that ATM? Right now the price of ATM options makes it hard for someone with a small account to make very many trades.
Please reply so I might be able to select the proper option for a small account that is far OTM.