Time Decay

AAA

DEFINITION of 'Time Decay'

The ratio of the change in an option's price to the decrease in time to expiration. Since options are wasting assets, their value declines over time. As an option approaches its expiry date without being in the money, its time value declines because the probability of that option being profitable (in the money) is reduced.

Also known as "theta" and "time-value decay".

BREAKING DOWN 'Time Decay'

Time decay of an option begins to accelerate in the last 60 to 30 days before expiry, provided the option is not in the money. But in the case of options that are deep in the money, time value decays more rapidly. The market finds these options too expensive compared to other strike prices or futures. As such, the holders of deep-in-the-money options nearing expiry discount the time value to attract buyers and in turn realize the intrinsic value.

The greater the certainty about an option's expiry value, the lower the time value. Conversely, the greater the uncertainty about an option's expiry value, the greater the time value.

RELATED TERMS
  1. DvegaDtime

    The rate at which the vega of an option or warrant will change ...
  2. Speed

    The rate at which the gamma of an option or warrant will change ...
  3. Deferred Option Month

    The latter month or months of an option or futures contract. ...
  4. Expiration Date (Derivatives)

    The last day that an options or futures contract is valid. When ...
  5. Intrinsic Value

    1. The actual value of a company or an asset based on an underlying ...
  6. In The Money

    1. For a call option, when the option's strike price is below ...
Related Articles
  1. Mutual Funds & ETFs

    ETF/ETN Analysis: VelocityShares 3x Long Crude Oil

    Learn more about the VelocityShares 3x Long Crude Oil exchange-traded note, or ETN, a triple-leveraged debt security backed by Credit Suisse AG.
  2. Investing Basics

    Try Southwest Airlines Options To Avoid Risks

    Learn how to take a position in Southwest Airlines' stock using option strategies that have limited or defined risk.
  3. Options & Futures

    An Introduction To Gamma-Delta Neutral Option Spreads

    Find the middle ground between conservative and high-risk option strategies.
  4. Options & Futures

    Practical And Affordable Hedging Strategies

    Learn how to find and use the most cost-effective ways to transfer risk.
  5. Options & Futures

    Getting To Know The "Greeks"

    Understanding price influences on options positions requires learning about delta, theta, vega and gamma.
  6. Options & Futures

    The Importance Of Time Value In Options Trading

    Move beyond simply buying calls and puts, and learn how to turn time-value decay into potential profits.
  7. Options & Futures

    Options Risk Graphs: Visualizing Profit Potential

    With a single diagram, you can see how price, time and volatility affect potential gains.
  8. Trading Strategies

    Adjusting A Long Call Into A Butterfly Spread

    There are many key advantages offered to options traders who deal only in the underlying securities.
  9. Options & Futures

    Employee Stock Options (ESO)

    Employee stock options are a form of equity compensation granted by companies to their employees and executives.
  10. Options & Futures

    Option Spread Strategies

    Learn why option spreads offer trading opportunities with limited risk and greater versatility.
RELATED FAQS
  1. How can I use an out-of-the-money put time spread for downside risk?

    Long Put Calendar Spread An out-of-the-money put time spread can hedge downside risk by selling an out-of-the-money put ... Read Full Answer >>
  2. How is a short call used in a naked call writing option strategy?

    Selling Naked Calls A trader sells a naked call short at a strike price generally above the market for a premium amount. ... Read Full Answer >>
  3. How is a short call used in a collar option strategy?

    An investor uses a short call sold above the current market price to collect a premium in a collar option strategy. The core ... Read Full Answer >>
  4. Do options make more sense during bull or bear markets?

    Options and various option strategies can be used in bull and bear markets. Certain option strategies can be used to profit ... Read Full Answer >>
  5. How do you trade put options on E*TRADE?

    To trade put options with E-trade it is necessary to have an approved margin account. Investors may sign up for margin accounts ... Read Full Answer >>
  6. What are the most common momentum oscillators used in options trading?

    Perceptions about the momentum behind short-term price movements hold an especially crucial role in options trading. Technical ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Financial Crisis

    A situation in which the value of financial institutions or assets drops rapidly. A financial crisis is often associated ...
  2. Election Period

    The period of time during which an investor who owns an extendable or retractable bond must indicate to the issuer whether ...
  3. Shanghai Stock Exchange

    The largest stock exchange in mainland China, the Shanghai Stock Exchange is a nonprofit organization run by the China Securities ...
  4. Dead Cat Bounce

    A temporary recovery from a prolonged decline or bear market, followed by the continuation of the downtrend. A dead cat bounce ...
  5. Bear Market

    A market condition in which the prices of securities are falling, and widespread pessimism causes the negative sentiment ...
  6. Alligator Spread

    An unprofitable spread that occurs as a result of large commissions charged on the transaction, regardless of favorable market ...
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!