What is Theta in Options Trading

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Theta, one of my favorite Greeks when it comes to options trading and probably one of the more important ones as well. 

Let’s talk about the impact of theta, what exactly it is and how you can use it in your daily options  trading strategy

What is Theta in Options Trading?

Theta is one of the Greeks and it’s the measurement of the options time decay. 

Options have a time component that makes up their premium and, ultimately, they lose value as they get closer to that expiration date. 

Theta is the measure of the rate at which an options contract loses it’s value as that expiration date draws near. 

For example, let’s say we have a call option with the current price of $2 and a Theta of minus 0.1  

This means that options contract is going to lose 10 cents a day simply due to the loss of time value or time decay. 

However, Theta is not constant. That value is going to change and increases the closer you get to expiration. (Graph below) 

But, for the simplicity of this example, let’s say it stays constant at minus 0.1. 

That means in two days, assuming the price of the underlying stock hasn’t changed, the price of that options contract would fall to $1.80. 

The Complete Guide On Option Theta - The Option Prophet

How to Use Theta in Options Trading? 

Theta allows us to ask yourself “how quickly am I losing value simply due to the time lost with everything else held constant?”

This is extremely important if you’re buying weekly expiration or short term wall street bets type of trading strategies. 

With quick flips, you’re looking for significant price movements that can overcome any losses due to theta.

The downside is if the stock or market stays flat, you’re losing money to theta with every passing minute.

On the flip side, buying options with expiration dates further out allows for you to give a position time to develop as theta for long term options is lower.

If expiration is 60 to 90 days out, time is not eating into your premiums at a high of a rate as if the expiration was this week.

One great strategy for this is playing the run up to earnings. 

Just remember, don’t freak out if you’re buying weeklies or 0dte options and you start to see the value decreasing.

Key Takeaways About Theta

  1. Longer-term options have a Theta of almost zero

This is great to understand if you’re expecting a long-term trend reversal or a long-term trend to develop either to the up or down-side. 

  1. Theta is higher for short-term options 

Theta goes up dramatically as options near expiration, which is key. If you are looking to buy weekly options or monthly options, Theta is going to eat a significant portion of that. 

  1. High volatility stocks have higher Theta than low volatility stocks. 

Make sure to always check Theta before you open a position. It can tell you a lot about how the underlying price of the stock is expected to move.

At the end of the day, Theta is only one component of how options prices work and what’s happening to your positions.

However, the key is to understand that time is going to eat into your options premiums and that Theta is a measure of that decay.