What is Time Decay?
Could you tell me which strategy could be used to exploit time decay? Kim Dohyup To explain time decay, let’s consider an option you purchased at Rs 20 at the beginning of the month. At the end of the month, it is worth only Rs 12 despite no major changes in the price of the underlying. This decline in value is attributable to the time value component, which declines with passage of time. Time value is the excess price of the option, over and above its intrinsic value. In case of a call, the intrinsic value is the difference between the spot price and the strike. For puts, the intrinsic value is the difference between the strike and the spot. Time decay: The loss in option value due to the passage of time is called time decay. It is captured as theta in the option valuation model. Theta indicates the pace at which option premium declines as it approaches time to expiry. The time decay of an option increases exponentially as it nears the expiry date. The lesser the time left in the opti
Time decay refers to the process that takes place when the value of an option or options undergoes a period of dropping. This change in option price is usually attributable to an identifiable set of circumstances, and takes place just prior to the end of the life of the option. Investors tend to be on the lookout for signs that time decay is about to take place. Accurately gauging the incidence and rate of time decay makes it possible to take steps to respond accordingly. It is not unusual for an option to perform very well for most of its life, but begin to shift slightly in value one or two months before reaching the date of expiry. Many investors understand this, and do not see it as a cause for alarm. Often, the option will undergo a short drop period then rally toward the end of the period. However, when the drop continues, the option is in a state of time decay, and the investor has to determine whether or not to sell the option. Knowing the right time to sell when time decay bec
