Theta Decay: How Time Erodes Option Value

An option's price has two parts: intrinsic value (what it would be worth if exercised now) and time value (everything else). Time value shrinks as expiration approaches. That erosion is time decay, and theta measures how fast it happens.

What theta measures

Theta estimates how much an option's price falls per day, all else equal. A theta of −0.05 means the option loses about $0.05 per share per day, or $5 per contract with a 100 multiplier.

• Long options have negative theta: time works against you.
• Short options have positive theta: time works for you.

Decay is not linear

Time value decays slowly when expiration is far away and faster as it approaches. For at-the-money options, the time value is roughly proportional to the square root of the time remaining. In that model, an option with a quarter of the time left keeps about half its time value, not a quarter. The last weeks before expiration are where decay is fastest.

Moneyness matters

• At-the-money options have the most time value, and the most theta in dollar terms.
• Out-of-the-money options have only time value, and it can disappear quickly near expiration.
• Deep in-the-money options are mostly intrinsic value, with little time value to lose.

Theta and gamma go together

High theta near expiration comes with high gamma. Short options sellers collect fast decay but face sharp losses if the price moves. Long option holders pay decay but gain quickly if the price moves. This trade-off is at the heart of most options strategies. See the options greeks.

Using theta in strategy

• Premium sellers often sell options 30 to 60 days out and close before the final weeks, aiming to collect decay without the extreme gamma risk. See credit spreads and iron condors.
• Option buyers often buy more time than they think they need, so decay is slower while they wait for the move.
• Calendar spreads sell a near-term option and buy a longer-dated one, aiming to profit from the faster decay of the short leg.

Weekends and holidays

Option models count calendar days, so prices typically already reflect weekends before they arrive. Expecting a "free" weekend of decay by selling on Friday is usually disappointing.

In TradeThink

Each option position shows live theta on the open positions page, and the risk profile shows the difference between the payoff today and at expiration, which is largely time decay.