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Options Jive

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Theta Relationships

Options Jive

Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.

Theta is the option Greek that is arguably the most important to a tastytrader’s success. It’s the rate at which the premium on the option decreases over time (which is why it is also referred to as “time decay”). The more time there is until the option expires, the more the underlying can move so the premium built into the option’s price will be higher. Larger Theta and higher premium levels usually mean higher Implied Volatility (IV). That results in greater opportunity. A graph comparing the premium levels with 45 days to expiration (DTE) in the SPY when it's Implied Volatility was 30, 17 and 13 was displayed.

A graph of an options decay over 200 days was shown. The amount the option lost to Theta between days 200 and 150, 150 and 100, 100 and 50 and 50 to zero were shown on the graph. The last 50 days decline in premium due to Theta is almost equal to the other 150. This is why we sell premium in this area. We like to avoid trading too close to expiration though, because the Gamma risk offsets the increased Theta Decay.

A graph displayed a plotting of Theta versus strike price on a $100 stock with an Implied Volatility of 20% and 45 DTE. The graph showed that at-the-money (ATM) options have the largest Theta Decay. That is because ATM options have the largest extrinsic value and it is why we manage winners on Straddles sooner. Deep in-the-money (ITM) option and out-of-the-money (OTM) options have less time premium since they have a lower probability of the strikes being touched. A final graph compared the Theta Decay of the ATM put ($100 strike), the ITM Put ($110 strike) and the OTM Put ($90 strike). The graph showed that as the options near expiration, the ATM options Theta Decay accelerates while the ITM and OTM decay slows down.

For more information on Theta see:

Best Practices from April 27th, 2016: “Differences Between Theta & Extrinsic Value”

Watch this segment of Options Jive with Tom Sosnoff and Tony Battista for the important takeaways and a better understanding of how Theta works and can work to our advantage.

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