An Option Theta measures the rate of decline in a stock option due to the passage of time. Theta can also be referred to as time decay. Options that have less than one month of life experience accelerated time decay. Theta belongs to a group of stock option measures called “the Greeks”. Theta is expressed in terms of the dollar value that a stock option will lose on a daily basis if the stock is flat. For instance, a Theta of $.01 means that an option will lose a penny a day if the stock doesn’t move. Options that are months from expiration have a very low Theta because they have plenty of time. Out of the money options that expire in a few weeks have a very high Theta. They are running out of time and the stock has to make its move quickly. This measure helps traders manage positions and they can roll front month options into longer-term positions when the Theta reaches certain levels. Most option traders prefer to sell from month stock options with only a few weeks of life. They have a high probability of expiring worthless. If you use this strategy, make sure there aren’t any pending news items prior to option expiration.
December 30, 2008