A Normal Guy's Guide to Theta in Options

Stock options are something that people decide to use way too soon. They often don't know that there are multiple variables which affect the price of an option. One thing that most people don't realize about options is that even if the price of the underlying goes up, it doesn't necessarily mean that you will make money on the option. Depending on the strike, duration, and a couple of other factors, you could very easily lose money even when you figured that you investment was a sure thing. One of the things that often affects this is the theta of an option, and this guide will teach you exactly how to adjust for this unknown variable.

Simply put, the theta of an option represents an amount of money that the option loses each day that it gets closer to expiration. In theory (and most of the time in practice as well), you will lose money each day that you or anyone else has this option. In fact, even if the option doesn't exist, it still loses value in theory until it is written by one party to another party.

One way to minimize your loss due to theta decay and also maximize your delta (another variable that determines your profit or loss on options investing) if you need to buy calls or puts is to buy them only when you need them and to buy them for a short period of time. One of the problems with this is that you will have a higher level of theta decay (you will lose more theoretical money each day) but if you can time an investment in a specific stock, your investment in an option will give you good leverage at a minimum of theta decay.

Another option is to buy long dated options (options that aren't going to expire for a long time). The benefit of these is that since theta decay increases exponentially as you get closer to expiration, you will lose less money each day that you own the option. If you don't exactly time your investment right, you will lose the minimum amount of money each day due to theta decay. The downside of this is that you have a smaller delta and therefore you don't have as much leverage so your investment will not be as effective as if you had a closer dated option.

One thing you should always keep in mind when thinking about theta is that it isn't something which affects the price of an option every day but rather it is something that happens over the period of many days or weeks, so do not think that you can game the system one day and then sell an option the other day to scalp theta, because that is not the way it works.