Theta: What It Means in Options Trading

What is theta?

Theta (θ) is the options “Greek” that measures time decay — the rate at which an option’s value erodes as it approaches expiration. It is commonly quoted as the amount an option’s price will change per day, all else equal.

How theta is expressed

• For long option positions, theta is usually negative: the option loses value each day.
• For short (written) options, the time decay works in the seller’s favor and is effectively positive for the position.
• Theta is quoted per share; one standard options contract covers 100 shares (so multiply by 100 to get dollar impact per contract).

Time decay, extrinsic value, and expiration

• An option’s total value = intrinsic value + extrinsic (time) value.
• Theta reflects the loss of extrinsic value as time passes. At expiration extrinsic value falls to zero, leaving only intrinsic value (if any).
• Longer-dated options carry more extrinsic value because there is more time for the underlying to move; therefore they have lower daily theta than shorter-dated options (but more total premium at risk).

Theta across moneyness and maturity

• At-the-money options typically have the largest absolute theta, especially as expiration nears.
• Deep in-the-money and deep out-of-the-money options have smaller absolute theta.
• As expiration approaches, theta generally accelerates (time decay ramps up).

Theta and the other Greeks

Theta is one of several Greeks used to measure option sensitivities:
* Delta — sensitivity of option price to a $1 move in the underlying.
* Gamma — sensitivity of delta to a $1 move in the underlying.
* Vega — sensitivity of option price to a 1 percentage point change in implied volatility.
These Greeks interact: for example, changes in volatility (vega) can change option premium and therefore alter the effect of theta.

Theta and volatility

• Higher implied volatility increases option premiums, which can increase the absolute dollar amount of daily time decay (theta).
• But high volatility can also drive option prices up if the underlying’s expected moves increase, potentially offsetting or overwhelming theta’s erosion.

Practical points

• Who benefits: Sellers benefit from theta (time decay), because the option they sold loses value over time. Buyers are disadvantaged by theta.
• Weekends/holidays: Theta generally accounts for calendar days, so time decay includes weekends and holidays.
• Positive theta: While the option’s theta value is typically negative, a short position realizes a positive effect from time decay. Traders often call selling options a “positive-theta” strategy.

Example

Imagine a call option on TechCo:
* Underlying price: $50
* Strike: $52
* Time to expiration: 30 days
* Option premium: $2.00 per share ($200 per contract)
* Theta: -0.05 per day

If nothing else changes, the option loses $0.05 per share per day to time decay. After 10 days the expected decay is 10 × $0.05 = $0.50, reducing the option premium from $2.00 to $1.50 (or from $200 to $150 per contract).

Key takeaways

• Theta quantifies the daily erosion of an option’s extrinsic value as expiration approaches.
• It is generally negative for long options and favorable to sellers.
• Theta is largest (in absolute terms) for at-the-money options and accelerates as expiration nears.
• Consider theta alongside other Greeks (delta, gamma, vega) and market conditions (volatility) when forming option strategies.