Stock option Greek Theta

- Stock option pricing-

The effects of time decay on stock options

As always, we are going to keep this option simple, not option complex. Theta is the measurement of how much premium is lost in an option contract every single day that passes by.

Remember, stock options have time value. At expiration, all that is left in the option contracts premium is the intrinsic value of the option.

Think of an option contract as a balloon. Time value is all the hot air in the balloon. The longer the option contract has until expiration, the bigger the balloon. Then some kid comes along (the market) and slowly lets the air out of the balloon. Once the air is let out of the balloon, all that is left is the balloon itself. Compare this example to an option contract that expires in 4-6 months. There is a lot of time value left in the option contract. Every day that passes by, the time value slowly comes out. At expiration all that is left is the true value (intrinsic value) of the option contract.

When going long options(buying). You are considered negative theta, because time decay is working against you. When going short or selling options you are considered positive theta, because the passage of time has a positive effect on your short option position.

Although some will say that option sellers are smarter than option buyers. This is not necessarily true. It all depends on what you are trying to achieve. Options are fascinating financial instruments that can fit into almost anyone's trading and investing goals.

The bottom line is that Theta is a very important option concept because it allows you to gauge how much premium is lost on a daily basis due to the passage of time. This will help you make a better informed decision on wether to participate or not.

remember: Options are NOT!!! investments. Options offer alternatives. Be smart and stay in the game. Good Luck!