Theta is a measure of time decay for an option. An option’s theta represents the decline in theoretical value per day with all other factors remaining constant.
Long calls and long puts have a negative theta, as their time value erodes with each passing day. To the option buyer, this time decay works against their position as the extrinsic time value erodes.
Short calls and short puts have a positive theta. This benefits the option seller, as the erosion of their time value makes the position become more profitable (being that the trader wants those options to become worthless). Option sellers, or premium sellers, benefit from a positive theta. This is because the price of the underlying asset does not need to change in order for a short option position to profit, due to the passage of time and the subsequent erosion of that time value.
It’s important to understand that an option’s theta, or time decay, is not linear. That is to say that the theta value of an option will change over time in an accelerating fashion as expiration approaches.
For example, with 30 days remaining until expiration, the theta for a short option might be $2.60. If all other factors remain constant (price, implied volatility, etc.), then with just 7 days remaining until expiration the theta value will have grown exponentially. That option will not decay exactly $2.60 per day.
Return to the main trading glossary page to learn more terms.
