In options trading, Time Value or Theta is a crucial concept that denotes the rate at which an option’s price decays or decreases as time progresses towards its expiration date. It measures the sensitivity of an option’s price in relation to time.
Options lose value as they get closer to their expiration date – a process known as time decay. Theta represents this time decay, and is usually expressed as a negative number indicating how much the option will lose in value per day, assuming all other factors remain the same.
For example, an option with a Theta of -0.05 would lose five paise in value daily. As an option gets closer to expiration, its Theta usually increases because the option starts losing value more rapidly. Consequently, Theta is considered a risk for option buyers and an advantage for sellers.
Knowing the Theta of an option not only provides an estimate of the risk associated with time decay, but can also help investors make more informed decisions. Understanding this crucial term is essential for developing a holistic understanding of the options market.
