See: Theta Decay.
It sounds like what happens when you don't floss, but it actually refers to the way that the time value of a stock option decays or declines with time.
The closer to the expiration date, the smaller the time value of the option. (Time value: as in...if you had an option to buy KO for $50 when KO is today trading at $42, and that option expired in 2 weeks, it probably wouldn't be worth much, because the odds of KO trading much above $50 in the next 2 weeks is relatively low. But if you had Theta (or time) of 3 years before the option expired, then yeah, that option could be worth a ton.)
Example:
You sold puts on GOOG at $450 for $35 which expire in 4 months. The stock today is at $600. That is, you sold the right for someone to make you buy shares of GOOG at $450 any time between now and 4 months from now for 35 bucks. Things go along and, well, GOOG just stays pretty flat, doing a whole lot of nothing.
It's now 3 days before those put options expire (we've gone 3.9 months with a whole lot of nothing happening in GOOG). The stock is still around $600 a share. What are the odds it plummets $150+ in 3 days? Really low. So the value of those puts is almost fully expired—its Theta has decayed to just 3 days' worth of trading time, and it is highly likely you just collect your 35 bucks, walk away, and buy yourself a really nice burger at a Manhattan eatery.
Related or Semi-related Video
Finance: What are Theta and Theta Decay?10 Views
finance a la shmoop what are they two and theta decay well in Wall Street
parlance theta is just time you know parsley sage rosemary and our nevermind [Parsley, sage and rosemary plants appear]
okay this is time like with a calendar the tea there in theta
it stands for time or tick-tock and in this case theta refers to the amount of
time left on a contract as that contract gets closer to expiring or executing [Timeline of contract expiration date]
well you'd say that the theta decays like a molding old skeleton returning [Decayed skeleton appears in grave]
ashes to ashes dust to dust so yeah when theta decays the amount of
time left on a contract a trade the life of a stock option lessons most commonly
theta decay is applied to the time remaining on stock option contracts
well what theta is it yep example theta all right so let's say you paid five
bucks a share for a call option to buy Comcast shares for 40 bucks a share [Call option for comcast appears]
anytime in the next four and a half months the stock trades today at $34 a
share well if the stock were still at thirty four bucks a share four months [Calendar months fall off the wall]
later ie with only two weeks or a ten trading days left well what would you
guess your call option to buy Comcast at forty bucks a share or six dollars above
where it's currently trading would be worth more than five bucks less you know
way less for that option to be worth anything positive the stock would have
to go above forty or appreciate seventeen and a half percent ish in ten
days and nobody would then pay an incremental five bucks above that figure [Cash thrown onto a fire]
to then buy the shares for an all-in cost of forty five bucks trying to make
money like the stock would have to zoom from 34 to fifty bucks a share to really [Man holding comcast stock]
have a good outcome risk adjusted so as the option got closer to expiring its [Call option moves to expiration date]
value would decay because the optionality got less there's less time
for that stock to break fifty bucks and change if there were a thousand trading
days in the future and the option had notionally like five years before it
expired like enormous theta well then it would likely have sold for
vastly more than five bucks a share you know for that stock option and hey if [Piles of cash appear on table]
you want to see real decay well just check out Simon and Garfunkel lately
looks like they're you know homeward bound [Man discussing Simon and Garfunkel]
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