When someone first enters the market, you will begin by purchasing stocks.
However, as time passes, if you invest a larger portion of your money in stocks, it leads to a worrying position.
As you can see, the stock market is erratic and if you have all of your money invested in equities, your investments may lose some of their value.
This is why after some traders have invested in stocks, they move towards options trading.
This is a type of contract between two parties where the buyer will purchase the right but not the obligation to purchase stocks when they reach a certain price before the options’ expiry date.
To ensure the trader’s safety through options trading, you can use options Greeks.
In this article, we will discuss Theta, which is one of the option Greeks used in option trading.
Options Greeks
It is important to discuss what options Greeks have before we get into Theta.
Option Greeks are a form of financial measurement which are based on mathematical formulas.
These formulas help the trader to calculate the price of options against other factors like the market volatility or the price of the underlying assets.
If a trader has brought an option agreement, then you will want to know if you should be exercising your right.
By using Options Greeks, you can then predict if the price of that option will either rise or fall.
There are 5 option Greeks that make up the option Greeks. These are Delta, Gamma, Vega, Theta, and Rho.
What Is Theta In Options?
Theta options are described as an options Greek that gauges how quickly an option’s temporal value depreciates as the expiration date approaches.
It measures how quickly the option price is reducing over time.
Theta in options is also known as time decay of an options contract, since it monitors the value that is losing over time.
The main premise of the Theta options is that, provided all other factors remain constant, an options contract will always lose value as it approaches maturity and become less interesting to investors.
Options’ theta value is always negative because it is deducted from the options contract’s rupee value on a certain day.
For example, the theta may be -3 but everything else is constant. The opinion value for that certain say will erode by 3 points.
Understanding Theta Options
As we have established, Theta is part of the option Greeks, which is all about the pricing of option contracts and when to exercise those options.
You will find that an options contract will give you a strike price which is a predetermined price.
Then the buyer of the option can choose when to exercise the right that option gives them at the right time.
The time frame of that opinion is very important, because the time frame is what makes the base of the theta calculations.
Theta options will determine the risk that traders will take on due to the decaying time, as every option’s contract has an expiry date.
Thus, the amount of profit that you can make from an options contract will decrease in time the closer the contract gets towards its expiry date.
Or if the option expires without being exercised, then the option is seen as worthless.
Although, if an options contract has a longer expiry date, then it is perceived as more interesting because it has more time to be profitable and for the stocks to reach their desired price.
Therefore, if you compare the value of two option contracts that have the same underlying asset and strike price.
You will find that the options contract that has more days left on their expiration date will have a higher value than the other.
This is due to time decay and how an option contract can lose their value every time it gets closer to its expiry defined by Theta.
How To Calculate Theta In Options?
Depending on the options’ time frames, the Theta value can be either negative or positive.
Theta in options, for instance, has a negative value for long positions and a positive value for short holdings.
Options always present the theta as the premium or rupee amount, and it can be calculated daily or monthly.
However, since the entire process is theoretical, investors employing Theta in options should be aware that the numbers are not exact.
Theta values operate under the presumption that price fluctuations and volatility are constant.
As a result, an options contract’s rate of time decay is somewhat unpredictable and subject to vary the following day.
Every day is different on the market for traders, therefore everything is always an estimate of what could possibly happen.
The act of selling an option is referred to as a positive theta trade and the act of buying an option is referred to as a negative theta trade because theta in options is regarded as a good technical factor for options sellers but not for options buyers.
Final Thoughts
Once a trader has become comfortable buying or selling stocks, they will turn their head to options trading.
Every option, whether it is a call or put option will start to lose its value as it reaches its expiration date.
A lot of traders like to get a better understanding of time decay and how much their contract could lose their value during a specific time frame. This is where Theta opinions come in.
We hope this article has helped you gain a better understanding of theta in options and how you can calculate it yourself.
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