Introduction to Options Trading Options can be described as an instrument of derivative value that is determined by the value of another asset or Security. Options allow the buyer the ability to purchase or sell the asset, while the seller is bound to guarantee the contract." In addition, as stated previously there are two kinds of options: call Options (right to purchase) as well as put Options (right to offer) The call option allows the an option buyer to purchase the security that is underlying at a set price. The person buying the option expects that the price will increase in the near future. Put options provides the right for the an option buyer to purchase the security that is in question at a set price. The person buying the option anticipates that the price to fall in the near future. Before we get into the strategies of options we must know the notion of the moneyworthiness in an investment. Option Greeks are a range of variables that aid the option trader when trading options. With the aid of these Greeks they are able to determine the value of options and understand volatility, control the risk, and so on. They Greeks also have a significant influence on one another. In this article, we shall discuss the greeks in the options market. There are five of them. They are delta, gamma, theta, vega and rho. These greeks are nothing but the five important variables that measure the risk that is involved in the options trading. By understanding the Greeks you can make good profits in the market. In this article, we’ll learn one of the primary Greeks i.e. the Theta.
What is Theta in Options Trading?
Option sellers are believed to have Theta as their best friend. This is actually true. But first let us understand what Theta is. Theta is a measurement of the effect time decay has on its value option contract. As time passes an option contract's value decreases every day because of time decay. This is referred to as "theta erosion."
If you place your bet when you are still a long way from the expiry date, the value of the options contract will be greater and therefore the cost would be greater. Theta options are defined as an options greek that measures the rate at which the option loses its time value as the expiration date draws near. It is the rate of decline in the option price over time. Because it measures the losing value based on time, Theta in options is sometimes also referred to as time decay of an options contract. Options buyers have negative theta. This means that they lose money slowly every day. However the option seller has positive theta which means they earn money slowly every day. You see, Theta works in favor of the option seller. This is the reason the reason why option sellers are believed to have Theta as their best friend. Options that are at-the-money will have an increased theta due to the fact that there is less time to make a profit from a movement in the security. Theta's impact is usually minimal during the initial days of an option contract. But as the expiration date approaches theta increases and premiums decrease more rapidly. This is due to the fact that the impact of time value is more in the days leading up to the time of expiration. Here are a few things to remember in regards to Theta.
1. Theta is a friendly Greek to option sellers. 2. If all other variables are constant at the same level, options contracts loss the money daily due to theta. 3. Time travels in a single direction. Therefore, theta is always a positive number. In the Decoding Option Greeks blog, we have also discussed how vega, delta, and gamma affects the pricing of Option premium with respect to the change in underlying price. And in case, you already know the basics of Options, we have backtested option trading strategies for you.