Where do I learn about the options decay?

Where do I learn about the options decay?

I am exploring options trading for a past few days and want to know more about how the premium works. I see that there is a decay in premium with passage of time. How/where do I learn about it?

View on r/IndianStreetBets by comeflywithsavage

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  2. Hi u/comeflywithsavage –

    This is a great question and something that definitely should be considered when trading options. Many option traders focus on current week expiries or even expiration day (0DTE). Time decay is an artifact of intrinsic vs. extrinsic value. Once at option is expired, it will only have the intrinsic value: difference between the underlying price and strike price. Prior to expiry, there will also be time value (or extrinsic value). The further away from expiry, the more time value. This is because there is more time for the underlying to move and make the option valuable. If the volatility is higher, then there will also be more extrinsic value because the underlying is moving more which creates a better chance of the option becoming valuable.

    If you look at an option chain, you should find the value for ‘theta’. This is the amount that the option contract will lose in premium if you hold overnight. Theta is a negative value for both calls and puts. If you look at various expiries, you can see that theta is higher both as a value and as a percent of the premium the closer to expiry that you are.

    For example, the 19800-strike call on the Nifty expiring next week has a price of 92.00 and theta of -7.62. The same strike on the month-end expiry has a price of 139 and theta of -5.48. This means that in one day, the 1-week contract will lose 8.3% of its value and the further out expiry will lose 3.9% of its value.

    When trading, you need to consider this. If the underlying doesn’t move in your favor today, then you need to be aware that it needs to move even more tomorrow in order to turn a profit. This amount is less if you hold a longer-term contract. The trade-off is that the longer-term contract will cost more.

    Lastly, if you want to learn more about this and the other Greeks, we recommend “Options Volatility” by Sheldon Natenberg. Of particular interest may be the chapters on Risk Measurement. Hope this helps!

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