Every option loses value as time passes. This is called theta decay or time decay. Understanding it is crucial because it affects every options trade you make. Let us explain how it works.
What is Theta Decay?
Theta decay is the daily loss in an option's value due to the passage of time. Every day that passes, your option is worth a little less, all else being equal.
Simple version: Options are like melting ice cubes. They slowly lose value every day until expiration. Theta tells you how fast they are melting.
How Theta Works
Theta is expressed as a negative number for option buyers. If an option has a theta of -0.05, it loses $5 per contract per day.
- Option buyers: Theta works against you. Your option loses value each day.
- Option sellers: Theta works for you. You profit as the option decays.
Example
You buy a call option for $3.00 with theta of -0.05.
If nothing else changes, tomorrow that option will be worth $2.95. In 10 days, it will be worth $2.50 just from time decay.
This is why option buyers need the stock to move in their favor to overcome time decay.
Theta Accelerates Near Expiration
Theta is not constant. It accelerates as expiration approaches. This is one of the most important things to understand.
- 60 days out: Theta decay is slow and steady
- 30 days out: Theta starts to increase
- 14 days out: Theta accelerates noticeably
- 7 days out: Theta decay is rapid
- Final days: Theta decay is extremely fast
Where Theta is Highest
Theta is not the same for all options:
- At-the-money options: Highest theta. They have the most time value to lose.
- Out-of-the-money options: Moderate theta. Less time value, but it decays quickly near expiration.
- In-the-money options: Lowest theta. Most of their value is intrinsic, which does not decay.
Using Theta to Your Advantage
For Option Buyers
- Buy options with more time until expiration to reduce daily theta burn
- Avoid holding short-dated options unless you expect a quick move
- Consider the cost of theta when planning your trades
For Option Sellers
- Sell options with 30 to 45 days until expiration for optimal theta capture
- At-the-money options give you the most theta, but also the most risk
- Consider closing winners early rather than waiting for full decay
Theta Gang Strategy
"Theta gang" is a term for traders who primarily sell options to collect premium and profit from time decay. Common theta gang strategies include:
- Selling covered calls
- Selling cash-secured puts
- Credit spreads
- Iron condors
Weekend Theta
A common question: does theta decay over weekends? Yes, it does. Options price in weekend decay gradually throughout the week, especially on Friday. Some traders sell options on Friday to capture weekend theta.
Track Your Theta Strategies
Pro Trader Dashboard tracks all your options trades and shows you how time decay affected your results.
Summary
Theta decay is the daily loss in option value from time passing. It accelerates near expiration and is highest for at-the-money options. Buyers fight theta, sellers profit from it. Understanding theta helps you pick the right strategy and manage your trades better.
Learn more about all the options Greeks or read about credit spreads.