Is Time Decay Kicking Your Butt

There are still a few weeks to go until options expiration, but it is never too early to start thinking about time decay. Time decay is a premium buyer’s worst enemy and a premium seller’s trusted friend.

An option’s pricing consists of two main elements –intrinsic value (the difference between the strike price and the stock price; out-of-the-money options have no intrinsic value) and time value, measured by the length of time until expiration. While intrinsic value is easy to quantify using simple arithmetic, time value is affected by implied volatility.

As expiration looms, time value dries up, meaning out-of-the-money options will expire worthless and in-the-money options will be worth only their intrinsic value.

Time value is non-linear and therefore decays at an increasing rate as the clock winds down.Time decay is measured by theta, which is the amount by which an option’s value will change when one day passes – all other factors being equal.

Dan Passarelli, Market Taker Mentoring
 


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