Theta, also known as time decay, is one of the essential “Greek” metrics used in options pricing. It measures the rate at which an option’s price declines over time, assuming that all other factors remain constant. This is because options are time-limited; hence, the value of the option will decrease as it moves closer to its expiration date.
Essentially, Theta provides an estimate of the amount that an option’s price will decrease each day, all else remaining equal. If an option has a Theta of -0.05, for example, its value will decrease by 5 paise per day. Theta is typically negative for purchased options, meaning the price drops as time passes.
However, for sellers of options, who benefit as the price decreases, this time decay and associated negative Theta can actually work in their favour.
