When you become more sophisticated as an options investor, you
start needing to understand more complicated options valuation
metrics like "the Greeks,"
a group of options equations named after Greek
. Today, we'll cover the ever important Greek letter of theta
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caption="Knowing theta is an important aspect of more complicated
Before delving into the concept of theta, first we must address
the concept of 'the Greeks' in general, as these metrics aren't
quite the same as other data used to evaluate equities or
derivatives. In fact, the Greeks are based on mathematical models
designed to predict the way an option will act in the future.
Because the valuation of options changes over time in a fashion
that is not entirely consistent with the underlying equity, having
a fundamental understanding of
these options are likely to perform going forward is
This is where theta comes in. Theta,
as defined by Investopedia
, is the "measure of the rate of decline in the value
of an option due to the passage of time."
It's important to understand that the valuation of theta is
based on an evaluation of an option at a given moment. Because the
underlying equity's valuation will change, theta will almost
invariably change as well. What you should take away from theta is
that this equation serves as a largely accurate predictive model of
options decay going forward.
Ok so we have a theoretical understanding of how theta works;
now, how do we use it to our advantage? Glad you asked.
Essentially, options traders would like, in general, to sell
options with higher thetas and buy options with lower thetas -- or
selling and buying options both with high thetas, as long as you
are selling a more valuable option and buying a less valuable, such
as in a call credit spread.
In particular, in the final two weeks before options expiration,
rapidly as the premium in a given option becomes less and less
valuable, giving traders an opportunity to profit. Employing such
strategies is embracing the fundamental concept that buying options
with high levels of intrinsic value and selling options with high
extrinsic value will, over the long run, yield more profitable
returns than speculating in options consisting primarily of