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Theta measures the effect of time on the value of the option. In general, Options decline in value as they closer to Expiration and theta is the rate which that process happens if all things are equal (i.e. there is no movement in the Underlying asset or commodity the option is based on). Theta is negative for holders of Long Options (calls or puts) and advantageous for those who are Short calls or puts (i.e. have sold them) because it has the effect of reducing the value of the option. At The Money Options are affected the most by theta as their Premium is composed of Time Value far more so than Out Of The Money or In The Money Options.

Theta increases in size as the date of expiry draws nearer, this has the effect of reducing the price of an option faster as time advances, as such, the rate of descent in value is not linear. This can mean that the owner of an option sees the value of it reduce even though the price of the Underlying has increased. If the effect of theta is greater than the change in price then the impact on the option's value will be higher. The effects of theta are one reason that some Options investors consider that only Short strategies (i.e. those that involve selling Options) are the more reliable way to generate profits over the longer term.
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Contributed by: Ralph Windsor

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Speaking Greek: Theta Decay (time decay)

An introduction to Theta and how it affects option prices.

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View Tasty Trade in Options Market Glossary Directory


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