Time value decay , the so-called "silent killer" of option buyers, can wipe a smile off the face of any determined trader once its insidious nature becomes fully felt. Buyers, by definition, have only limited risk in their strategies together with the potential for unlimited gains. While this might look good on paper, in practice it often turns out to be death by a thousand cuts. In other words, it is true you can only lose what you pay for an option.

It is also true that there is no limit to how many times you can lose. And as any lottery player knows well, a little money spent each week can add up after a year or lifetime of not hitting the jackpot. For option buyers, therefore, the pain of slowly eroding your trading capital sours the experience.

Now, to be fair, sellers are likely to experience lots of small wins, while getting lulled into a false sense of success, only to suddenly find their profits and possibly worse obliterated in one ugly move against them. Returning to time value decay as a risk variable, it is measured in the form of the non-constant rate of its decay, known as Theta. Theta values are always negative for long options because options are always losing time value with each tick of the clock until expiration is reached.

In fact, it is a fact of life that all long options, no matter what strikes or what markets, will always have zero time value at expiration.

Theta will have wiped out all time value also known as extrinsic value leaving the option with no value or some degree of intrinsic value.

Theta Trend - simple. objective options trading

Intrinsic value will represent to what extent the option expired in the money. For more, see The Importance of Time Value.

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As you can see from a look at Figure 7, the rate of decay decreases in the more distant contract months. The yellow highlights the calls that are at the money and the violet the at-the-money puts. The January calls, for example, have a Theta value of This rate of decay decreases for each back month call with a Theta of If we think of time value on these calls as if it represented just one July option, clearly the rate of loss of time value would be accelerating as the July call gets nearer to expiration i.

Nevertheless, the amount of time premium on the back months is greater. Therefore, if a trader desires less time premium risk and a back month option is chosen, the trade-off is that more premium is at risk from Delta and Vega risk.

In other words, you can slow down the rate of decay by choosing an options contract with more time on it, but you add more risk in exchange due to the higher price subject to more loss from a wrong-way price move and from an adverse change in implied volatility since higher premium is associated with higher Vega risk.

In Part VIII of this tutorial more about the interaction of Greeks is discussed and analyzed. The common options strategies have position Theta signs that are easy to categorize, since a selling or net selling strategy will always have a positive position Theta while a buying or net buying strategy will always have a negative position Theta , as seen in Figure 8.

Conclusion Interpreting Theta both position and non-position Theta is straightforward. Looking at Theta horizontally across time and vertically along strike price chains for different months, it is shown that key differences in Thetas inside a matrix of strike prices depend on time to expiration and distance away from the money.

The highest Thetas are found at-the-money and closest to expiration. Finally, position Theta for popular strategies is presented in table format. Dictionary Term Of The Day. A measure of what it costs an investment company to operate a mutual fund. Latest Videos PeerStreet Offers New Way to Bet on Housing New to Buying Bitcoin? This Mistake Could Cost You Guides Stock Basics Economics Basics Options Basics Exam Prep Series 7 Exam CFA Level 1 Series 65 Exam.

Options Greeks: Theta Risk and Reward

Sophisticated content for financial advisors around investment strategies, industry trends, and advisor education. Theta Risk and Reward By John Summa Share. Options and Risk Parameters Options Greeks: Delta Risk and Reward Options Greeks: Vega Risk and Reward Options Greeks: Theta Risk and Reward Options Greeks: Gamma Risk and Reward Options Greeks: Position Greeks Options Greeks: Inter-Greeks Behavior Options Greeks: IBM options Theta values. Values taken on Dec. OptionVue 5 Options Analysis Software As you can see from a look at Figure 7, the rate of decay decreases in the more distant contract months.

Strategies Position Theta Signs Long Call Negative Short Call Positive Long Put Negative Short Put Positive Long Straddle Negative Short Straddle Positive Long Strangle Negative Short Strangle Positive Put Credit Spread Positive Put Debit Spread Negative Call Credit Spread Positive Call Debit Spread Negative Call Ratio Spread Positive Put Ratio Spread Positive Put Back Spread Negative Call Back Spread Negative Calendar Spread Positive Covered Call Write Positive Covered Put Write Positive Figure 8: Position Theta signs for common options strategies.

The position Theta s in this table represent standard strategy setups. These risk-exposure measurements help traders detect how sensitive a specific trade is to price, volatility and time decay.

We look at the different kinds of Greeks and how they can improve your forex trading. There are ways to control risks, reduce losses and increase the likelihood of success in your portfolio.

Find out how spreads can help. Move beyond simply buying calls and puts, and learn how to turn time-value decay into potential profits.

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