Time Decay (Theta)

Time Decay (also known as 'Theta') is the relentless enemy of the options buyer and the steadfast friend of the options seller. It measures the rate at which an options contract loses value as its expiration date draws nearer. Think of it like a melting ice cube: the moment you buy an option, its time value begins to evaporate, drip by drip, day by day, until nothing is left at expiration. This erosion of value is due to the decreasing uncertainty about where the underlying stock's price will be when the contract expires. The portion of an option's price that is subject to this decay is its extrinsic value (or time value). The closer the option gets to its expiration date, the less time there is for the desired price movement to occur, and thus, the less that time is worth. This daily loss in value is what Theta quantifies.

Theta is one of the key metrics, known collectively as the Greeks, used by traders to measure the different risks associated with an option's price. It is typically expressed as a negative number representing the dollar amount an option will lose per day, assuming all other factors like stock price and volatility remain constant. For example, an option with a Theta of -0.05 is expected to lose about $0.05 of its value every day.

Crucially, time decay is not linear. It doesn't happen at a steady, predictable pace. Instead, it accelerates, like a ball rolling down an increasingly steep hill.

• Long-Dated Options: An option with several months until expiration will lose value relatively slowly. Time is abundant, and so is the potential for the stock to make a favorable move.
• Near-Dated Options: In the last 30 to 45 days of an option's life, the rate of time decay speeds up dramatically. The clock is ticking loudly, and the probability of the option finishing “in the money” (having intrinsic value) diminishes with each passing day. For an option buyer, this is a powerful headwind. For an option seller, this is when they earn their premium most rapidly.

Imagine you have a ticket to a concert that's three months away. You might be able to sell it for a good price. But if the concert is tonight and the show is about to start, that ticket's value is plummeting with every minute that passes. That’s time decay in action.

While many value investors stick to buying great companies at fair prices, a sophisticated understanding of options and time decay can open up conservative, income-generating strategies. The key is to put time decay on your side by selling options rather than buying them.

Instead of betting on a stock's direction and fighting against the clock, a value investor can act like an insurance company, selling policies (options) and collecting the premium.

• Covered Call Strategy: If you own shares of a company you believe in for the long term, you can sell a call option against those shares. You collect a premium upfront. Time decay then works in your favor, eroding the value of the option you sold. If the stock price stays below the strike price, the option expires worthless, and you keep your shares and the entire premium as extra income. You are essentially getting paid to wait.
• Cash-Secured Put Strategy: If there's a great company you'd love to own at a price lower than where it's currently trading, you can sell a put option. You collect a premium for agreeing to buy the stock at a specific strike price if it falls. Again, time decay is your ally. If the stock stays above your strike price, the option expires worthless, and you simply keep the premium. If the stock does fall and you have to buy the shares, you get to do so at your desired price, with the premium you collected acting as an additional discount.

For the average investor, buying options purely for speculation is a losing game precisely because of time decay. You have to be right about the direction of the stock, the magnitude of the move, and the timing—all while Theta is eating away at your investment every single day. By contrast, by conservatively selling options on stocks you already own or wish to own, you transform time decay from a wealth-destroying foe into a reliable, income-generating friend.