expiring the following day, it will lose 100%
of its remaining extrinsic value over the
next 24 hours.
That’s why the theta of an option increases as time to expiration decreases.
And it’s why a trader who’s short an option
profits as time passes, all else being equal.
But all things aren’t always equal. And
theta is impacted by volatility.
I T’S ALL IN THE VOL
Volatility and an option’s extrinsic value are
related. In theory, when volatility goes up,
an option’s extrinsic value rises. That suggests theta has a bigger impact on an option
when volatility is higher—because it has to
erode more extrinsic value by expiration.
For example, if SPX is at 2738, and vol is
at 21%, then the theta of the 2700 put with
60 days to expiration would be $0.65 per
day. If vol was at 30%, then the theta of that
same put would be $1.01.
Theta is often also highest for ATM options because extrinsic value is highest for
ATM options, and moves lower for options
that are further OTM. In effect, theta has to
whittle down more extrinsic value for ATM
options than it does for O TM options.
As a trader looking to make money from
theta, you want to analyze it in a dollar
amount. To do that, multiply the option’s
theoretical theta by the option’s multiplier
(typically $100 for U. S. equity and index
options, but varies with options on futures),
and then by the number of contracts you
plan to trade. Conveniently, the thinkorswim® platform from TD Ameritrade does
Thomas Preston and Doug Ashburn are not representatives of TD Ameritrade, Inc. The material,
views, and opinions expressed in this article are
solely those of the author and may not be reflective
of those held by TD Ameritrade, Inc.
For more on the risks of trading and trading
options, see page 37, #1– 2.
FIGURE 2: Decaying value. As time passes, an
option may lose extrinsic value. For illustrative purposes
only. Past performance does not guarantee future results.
MORE TO THE POINT,
HOW CAN ONE
SINGLE DAY HAVE
IMPACTS ON OPTIONS
DAYS TO EXPIRATION?
this for you. To see the total theta of your
positions—positive and negative—look at
the Position Statement section under the
Yet, as we’ve seen, theta is a moving
target. As time, stock price, and volatility
change, so does theta. So if you want to
maintain a certain level of theta for a particular strategy, or even your entire portfolio,
monitor your positions closely to make sure
you stay within target parameters. Otherwise, it might be time to tweak, roll, or close
And if you typically beta-weight your
portfolio, there’s no need to do so with
theta as you would with, say, your delta or
vega exposure. Unlike those greeks, for
which you might want to normalize to a
benchmark such as the S&P 500, theta is
just what it is. Time passes for that high-fly-ing tech name at the same rate as for SPX or
SO MUCH OF TRADING, AS WI TH LIFE,
is in flux—up one minute and down the
next, with the occasional sharp turn sideways. Yet time marches on. This is your
options position, and it’s decaying. One.
Day. At. A. Time.
90 days to
60 days to
30 days to