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Finance Glossary

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Theta Decay

Definition:

See theta. 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.

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.