© 2015 Shmoop University, Inc. All rights reserved.

Finance Glossary

Just call us Bond. Amortized bond.

Over 700 finance terms, Shmooped to perfection.

Theta Decay

Definition:

See Theta. When time decays or rather the stock option approaches its expiration date - the time value of the option "decays" over time.

Example

Okay, so you got the "T" in theta as being the same letter that kicks off the word "time." Clever.

So let's set up a trade: 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.

Advertisement
Advertisement