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Glossary
Theta
Definition
An approximation of the decrease in the price of an option over a period of time with all other factors held constant, to determine the price and potential returns of a trade. The change in value stems from the reduction in the time to expiration and therefore the reduction in the life of the option.
Theta is generally expressed on a daily basis. For example, if a call has a price of USD 3 and a theta of 0.10, one day later, with all else unchanged, the call would have a price of USD 2.90 (USD 3 - (.10 x 1)).
Generated by a mathematical model, Theta depends on the stock price, strike price, volatility, interest rates, dividends, and time to expiration.
What is theta?
In options trading, theta represents the rate at which the value of an option decreases as time passes, all else being equal. Also known as time decay, theta is a critical factor in the pricing of options, particularly as the expiration date approaches.
Why is theta important to consider when trading?
Theta is crucial for options traders as it affects the value of options over time. A high theta value means the option loses value quickly as expiration nears, which is important for traders holding options positions. Understanding theta helps in making informed decisions about the timing of entering and exiting options trades, especially in strategies that involve time decay, like selling options.