What You Didn't Know About Time Decay - Aussie Stock Forums

1. ## What You Didn't Know About Time Decay

Time decay is known by the greek word "theta" and what everybody knows about theta is that it accelerates in the last month of the options life, losing a substantial whack of its value in the last few days.

In every option text I've ever read, theta is universally depicted by a graph that is something like the following:

This is a graph of the time value of the last 90 days of an ATM option. As you can see, the rate of decay is more or less linear up until the last 30 days, whereupon it starts to decay at an accelerating rate, losing the remaining value very quickly in the last few days.

This is proof that if you short options you should choose options with about a month remaining because that is when most of the decay is.

Or is it?

The above is certainly true for At The Money options. But what about Out of The Money options? What the textbooks don't tell you is that for an option that is somewhat OTM (or somewhat In The Money for that matter) is that the above scenario is not quite true. The characteristics of theta change, the further we go OTM or ITM.

Lets look at a theta graph for an option that is somewhat OTM:

Lo! It seems in this instance, that theta does not accelerate in the final 30 days at all, but rather DECELERATES.

If we are short OTM options we will collect more theta by writing expiry further out... 60 or perhaps 90 days and wind them up before the last month.

This is where "options education" can sometimes be erroneous and it pays to observe, notice things, play around with your strategy modeler and/or excel spreadsheet and really become intimate with these option concepts. It does pay.

2. ## Re: What You Didn't Know About Time Decay

If you read my older posts on strangles you will notice I always go for 2-3 month expiry, so this is not a shock to me.

Anyway, from a risk point, it just seems silly to go for \$1k profit in 1 month as opposed to a \$3k profit over 3 months. Sooooo many times, traders Ive seen short an option with a week to expiry, thinking it has zero chance of expiring in the money, only to watch as the option goes from 2c to 40c overnight. oops!

3. ## Re: What You Didn't Know About Time Decay

Originally Posted by money tree
Anyway, from a risk point, it just seems silly to go for \$1k profit in 1 month as opposed to a \$3k profit over 3 months. Sooooo many times, traders Ive seen short an option with a week to expiry, thinking it has zero chance of expiring in the money, only to watch as the option goes from 2c to 40c overnight. oops!
The thing is, depending how far out of the money you go, it could be \$0.7k profit in 1 month as opposed to a \$3k profit over 3 months.

4. ## Re: What You Didn't Know About Time Decay

I searched for time decay on options and this thread is what I come up with.
Mainly a gripe but I really don't need to experience another "bad company" and at this point will not reveal the name.

I bought some listed share options a few years ago when they had an August 2010 expiry. So about 3 years from my purchase. Since then the company share price has gone down and with it the options price. What I have done is accumulate more at basement with time on my side. Due to the following reason the price has languished.

Strangely, the company deferred their production/exploration phase twice this year and what has happened because of this is - time decay on options. With a year to go they deferred a further 4 months leaving 8 months to expiry and the strike price is a long way away.

I really thought it would be in the companies best interest to get the share price over strike price. I wait patiently for the outcome and have this thread record to refer to in the future.

5. ## Re: What You Didn't Know About Time Decay

Originally Posted by Wysiwyg
I really thought it would be in the companies best interest to get the share price over strike price. I wait patiently for the outcome and have this thread record to refer to in the future.
And dilute their capital? No sensible company wants to do that
Esp if theres lots of oppies floating around. Getting rid of them would be like a share buyback for free.

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Thanks wayneL, I have never looked at otm/itm oppies in detail to appreciate the theta charts. Very interesting.

6. ## Re: What You Didn't Know About Time Decay

Originally Posted by skyQuake
And dilute their capital? No sensible company wants to do that
Esp if theres lots of oppies floating around. Getting rid of them would be like a share buyback for free.

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Thanks wayneL, I have never looked at otm/itm oppies in detail to appreciate the theta charts. Very interesting.
Oh no. Then what is the reason for having options if not for raising additional capital? The number of options are approx. 33% of listed shares.
Never again, I swear, never again.

7. ## Re: What You Didn't Know About Time Decay

Originally Posted by Wysiwyg
Oh no. Then what is the reason for having options if not for raising additional capital? The number of options are approx. 33% of listed shares.
Never again, I swear, never again.
If the directors hold oppies rather than shares its good; Otherwise its an opportunity for the company to literally enrich shareholders at the expense of optionholders. Very cunning

8. ## Re: What You Didn't Know About Time Decay

Originally Posted by Wysiwyg
I really thought it would be in the companies best interest to get the share price over strike price. I wait patiently for the outcome and have this thread record to refer to in the future.
What makes you think a company has control over their share price.

9. ## Re: What You Didn't Know About Time Decay

To the OP and anyone interested, Cottle too in his book "Coulda Woulda Shoulda," has some excellent depictions of Theta Decay in Chapter3.

10. ## Re: What You Didn't Know About Time Decay

Originally Posted by Azzachazza
To the OP and anyone interested, Cottle too in his book "Coulda Woulda Shoulda," has some excellent depictions of Theta Decay in Chapter3.
Thanks.

But I find his update "Options Trading: The Hidden Reality" more comprehensive.

Coulda Woulda Shoulda still excellent however.

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