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# Options Theta for Beginners

Theta is another measure of risk for options, and measures the rate that an option decreases in extrinsic value due to time. Theta is also often referred to as time decay.

In other words, Theta measures how much an option will decrease in value as time passes. Have you ever noticed the price of a position slowly going down throughout the day, despite there being little to no change in the underlying? Theta is the cause of this price decay. It is the reason options lose value as they approach expiration despite there being no change in the underlying asset.

Theta varies based on many factors, and changes constantly, so the number that is shown as theta is the time decay if no other factors change (IV, underlying price).

Similar to delta, theta differs according to the type of position held. Positive theta is shown to options sellers, and negative theta is shown to buyers. Buyers of any option, regardless of being long or short the underlying have a negative theta. If you are buying options, theta is hurting your position value .On the other hand, options sellers have a positive theta, meaning theta is beneficial to them, as theta leads to a decrease in the price of the option over time, even if the underlying does not change. Let's use an example to make this simpler. Say I sell an OTM 7 days to expiry naked call for \$1.00, and the underlying has a minimal change in price for the next 7 days. Due to theta, the option will have decreased in value, to let's say, 30 cents.

Now, I can go and buy back that naked call, closing the position, netting 70\$. I will have made money, despite the minimal change, due to theta. In short, theta is bad for options buyers, and good for options sellers.

The additional days till expiry gives the stock plenty of time to move, meaning you can sell the option any time during those 15 days if you are content with your return, or you can hold it until expiry, and exercise the option if the price is ITM. As it approaches expiry, there is increased perceived risk, leading to a decrease in value. To sum it all up, theta measures the decrease in extrinsic value for each day that passes until expiry (tastyworks)

Differences in theta for buyers and sellers or writers.

How does theta vary from position to position? At the money options have the highest theta because they have the most extrinsic value. If you don't know what extrinsic value is, don't worry, I will discuss both intrinsic and extrinsic value in a coming article. For now, all you need to know is that intrinsic value comes from the actual value of the option if it were to be exercised, in other words, it is the literal value of the option without factoring in data like volatility. Extrinsic value is the market price of an option, considering factors like volatility and time. As options move further out the money or further in the money, theta will decrease.

Here is an example of this. If I purchase a 15 DTE naked SPY call that is more or less ATM. Its current price is \$529, with a theta of -14.278. This means, after one day, the price of the option will be around \$515, all else equal (no change in IV, no change in underlying, etc). Here is another naked call, also 15 DTE, but this time, it is OTM by around 2.9% or \$10. This time, the theta is -9.219, meaning in one day, the price of the option will be around \$127 all else equal.

Here is another identical call option, 15 DTE, but now, its \$10 or 2.9% ITM. The theta value for this option is around -12.69, meaning it will be \$1321 in one day, all else equal. We saw three different naked call options, each with varying strikes but the same expiration. Each had a different theta, with the ITM and OTM options having lower theta values than the ATM option. I hope this helps illustrate the relationship between strike price and theta value.

• Theta is a measure of risk for options, measuring the rate that an option decreases in extrinsic value due to time.

• Theta is constantly changing and varies based on many factors.

• Options Buyers have negative theta, while options sellers have positive theta.

• Finally, ATM options have higher theta than ITM or OTM options.

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