It’s either zero for out-of-the-money (OTM) options, or the difference between the stock price and the strike price for in-the-money (ITM) options. Intrinsic value is affected only by where the stock price is relative to an option’s strike price. And because of time’s reliability, many option traders rely on theta.īut why do options prices decay in the first place? Keep in mind that an option’s price has two components: intrinsic and extrinsic value. Theta is a theoretical metric (a “greek”) that represents how much an option’s price loses, or decays, as one day passes to the next. Yes, time passes, and that’s why options have time decay - also known as theta - to the detriment of option buyers and the benefit of option sellers. Like our mortal selves, each flip of the calendar, from one day to the next, takes an option one day closer to its expiration date. But one thing doesn’t change: time marches on at a steady rate, and always in the same direction, one day at a time. Over longer periods, even dividends and interest rates change. In the short term, stock prices move up and down. Learn how volatility and extrinsic value of an option are relatedĪlmost everything that goes into an option’s price moves in two directions.Know what theta measures and how it may reduce the extrinsic value of an option.Understand the importance of analyzing, positioning, and maintaining theta.
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