We have changed our privacy policy. In addition, we use cookies on our website for various purposes. By continuing on our website, you consent to our use of cookies. You can learn about our practices by reading our privacy policy.


Theta Decay

Categories: Derivatives, Metrics

See theta. It sounds like what happens when you don't floss, but it actually refers to the way that the time value of a stock option decays or declines with time.

The closer to the expiration date, the smaller the time value of the option.

Example

You sold puts on GOOG at $450 for $35 which expire in 4 months; the stock today is at $600. That is, you sold the right for someone to make you buy shares of GOOG at $450 any time between now and 4 months from now for 35 bucks. Things go along and, well, GOOG just stays pretty flat, doing a whole lot of nothing. 

It's now 3 days before those put options expire (we've gone 3.9 months with a whole lot of nothing happening in GOOG). The stock is still around $600 a share. What are the odds it plummets $150+ in 3 days? Really low. So the value of those puts is almost fully expired—its THETA has decayed to just 3 days' worth of trading time and it is highly likely you just collect your 35 bucks, walk away, and buy yourself a really nice burger at a Manhattan eatery.

Find other enlightening terms in Shmoop Finance Genius Bar(f)