ShmoopTube

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finance a la shmoop what are they two and theta decay well in Wall Street

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parlance theta is just time you know parsley sage rosemary and our nevermind [Parsley, sage and rosemary plants appear]

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okay this is time like with a calendar the tea there in theta

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it stands for time or tick-tock and in this case theta refers to the amount of

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time left on a contract as that contract gets closer to expiring or executing [Timeline of contract expiration date]

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well you'd say that the theta decays like a molding old skeleton returning [Decayed skeleton appears in grave]

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ashes to ashes dust to dust so yeah when theta decays the amount of

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time left on a contract a trade the life of a stock option lessons most commonly

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theta decay is applied to the time remaining on stock option contracts

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well what theta is it yep example theta all right so let's say you paid five

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bucks a share for a call option to buy Comcast shares for 40 bucks a share [Call option for comcast appears]

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anytime in the next four and a half months the stock trades today at $34 a

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share well if the stock were still at thirty four bucks a share four months [Calendar months fall off the wall]

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later ie with only two weeks or a ten trading days left well what would you

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guess your call option to buy Comcast at forty bucks a share or six dollars above

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where it's currently trading would be worth more than five bucks less you know

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way less for that option to be worth anything positive the stock would have

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to go above forty or appreciate seventeen and a half percent ish in ten

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days and nobody would then pay an incremental five bucks above that figure [Cash thrown onto a fire]

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to then buy the shares for an all-in cost of forty five bucks trying to make

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money like the stock would have to zoom from 34 to fifty bucks a share to really [Man holding comcast stock]

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have a good outcome risk adjusted so as the option got closer to expiring its [Call option moves to expiration date]

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value would decay because the optionality got less there's less time

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for that stock to break fifty bucks and change if there were a thousand trading

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days in the future and the option had notionally like five years before it

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expired like enormous theta well then it would likely have sold for

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vastly more than five bucks a share you know for that stock option and hey if [Piles of cash appear on table]

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you want to see real decay well just check out Simon and Garfunkel lately

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looks like they're you know homeward bound [Man discussing Simon and Garfunkel]

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