Theta measures the time decay (time decay) of options. Theta can also be defined as the excess of an option's price over its intrinsic value, slowly affecting the value of options. in practical terms, it tells us the gain (or loss) we make as time passes.
Theta and time decay in options
Options have a predefined expiration time. Their time decay is exponentially faster as we approach the last day of trading.
For this reason, option buyers have negative Theta (thus having to liquidate their positions before expiration so as not to risk eroding all of their eventual profit) while sellers have positive Theta and consequently gain from the passage of time, keeping all of the premium collected at option expiration.
Long CALLs and long PUTs always have negative theta. Short CALLs and short PUTs always have positive theta. The stock has zero theta-its value is not eroded by time. Other things being equal, an option with more days to expiration will have more extrinsic value than an option with fewer days to expiration. The difference between the extrinsic value of the option with more days to expiration and the option with fewer days to expiration is due to theta. Therefore, it makes sense for long options to have negative theta and short options to have positive theta. If options continuously lose their extrinsic value, a long option position will lose money due to theta, while a short option position will make money due to theta.
But theta does not reduce the value of an option evenly. Theta has a much greater impact on an option with fewer days to expiration than on an option with more days to expiration. For example, PUT XYZ Oct 75 is worth $3.00, has 20 days to expiration, and has a theta of - 0.15. PUT XYZ Dec 75 is worth $4.75, has 80 days to expiration and has a theta of - 0.03. If one day passes and the XYZ stock price does not change and there is no change in the implied volatility of either option, the value of PUT XYZ Oct 75 will decrease by $0.15 to $2.85, and the value of PUT XYZ Dec 75 will decrease by $0.03 to $4.72.