Posts Tagged ‘option’

Theta Value of Options Final Part :)

Continuing the final part from where i have stopped writing……………. 🙂

.

At-The-Money options have the maximum time value, because intrinsic value can begin to rise at this point.

.

.The graph here indicates that the (absolute) value of Theta is highest at 2.67 for Nifty 5400 Call, which is At-The-Money (ATM) strike (which is at present the closest strike to the underlying’s spot value), as the strikes move away from ATM, and gets deep into the money or deep out of the money Theta and time value tends to decrease.

.

.

Coming to the relationship between time value and the length of time remaining to expiration, time value of an option decays at a non-constant rate, as its expiration date approaches and becomes worthless after that date. This rate of time decay is known as Theta, which measures the amount by which option’s value decreases per day.

.

.

Theta values are negative for all options as options are always losing time value while moving towards expiration, till options take zero time value at expiration. At expiration Theta wipes out all time value leaving the options with no value or some degree of intrinsic value. The most important characteristic of Theta is that it is not constant, as date of expiration comes closer, Theta increases, implying that the amount of time value decreasing from the option’s premium per day accelerates with each passing day.

.

.

As you can see from the graph the rate of decay (Theta) is lower in the contracts expiring in more distant months. The August 5400 Nifty call (which has 34 Days remaining to expiry), have a Theta value of -2.67; meaning this option is losing Rs.2.67 in time value each day. This rate of decay is lower for each forward month, e.g. September 5400 call (69 days remaining to expiration) has a Theta of – 2.12. But in case of the present July 5400 call option, (with volatility and price of the underlying held constant) the rate of loss of time value accelerates as the call option gets nearer to expiration (i.e., the rate of decay is much faster on the option near to expiration than with a lot of time remaining on it). With 6 days remaining to expiration Theta is -5.03, and with 1 day remaining to expiration value of Theta has increased to 8.32.

.

.

Considering time value and its dependence on volatility, higher volatility gives rise to higher time value as increased uncertainty about underlying’s price near expiration, tends to increase Theta.

.

.

In conclusion, while trading options one has to consider Theta decay risk carefully as the option price may fall exponentially near expiration. However option traders can turn time value decay into profits by trading net selling option strategies which always have positive position Theta as income will be generated through time value option premiums even if the underlying remains stationary and range bound and options expire worthless. Covered Call or Covered Put Writing, Calendar Spreads, Call or Put Ratio Spreads, Call or Put Credit Spreads, Short Strangle or Straddle and even simple Call Writing and Put Writing are few common option strategies which have positive position Theta.

.

OUR Websites:  http://www.smcindiaonline.com,http://www.smccapitals.com,http://www.smctradeonline.com
,http://www.smcwealth.com

.

Theta Value of Options Part 1 :D

In this article we try to discuss how time decay affects option pricing over time, though it is considered a significant risk factor, understanding the dynamics of time decay in option itself may reveal how to use it for incurring profits. As we  already know, most options have  a limited life span, i.e. till its expiration date. The option expiration date is the date after which the option contract becomes void and right to exercise it no longer exists. For all stock options listed on the National Stock Exchange, the expiration date falls on the last Thursday of the expiration month (except when that Thursday is a holiday, in which case it will be brought forward by one day to Wednesday).

.

Not only do options expire on the set expiration date they also keep loosing their value over time. This phenomenon of loosing time value overtime is called time value decay. The risk related to time value decay of option price can be hedged by choosing options which are to expire in more distant months, where there is longer time remaining to expiration. This can slow down the rate of decay but one has to pay higher premiums on forward month options, which subjects it to higher Delta risk of more loss from wrong-way price movement and higher Vega risk which can arise from adverse changes in volatility.

.

.The graph displayed here clearly shows that keeping volatility and price of the underlying constant, for the same At-The-Money strike of Nifty 5400 Call, for different expiry months the premium increases as the time remaining to expiration increases. For September expiry, when there are 69 days remaining to expiration the premium is `211, as we move towards August expiry the premium has decreased to `143.20 as only 34 days are left to expiration. Finally comparing it with present month expiry of July the Premium is lesser at `69.15 when there are 6 days remaining to expiration (which also includes some intrinsic value).

.

The premium or the option price paid to acquire any option has two components: intrinsic value and time value (also known as extrinsic value). The intrinsic value depends on the moneyness of the option. Only if the option is In-The-Money it will have intrinsic value. At-the-money options and Out-of-the-money options have no intrinsic value. The second component of the option premium is time value, the time value depends upon the length of time remaining to exercise the option, the moneyness of the option, as well as the volatility of the underlying’s market price. In case of In-The-Money options, the time value decreases as the option goes deeper into the money, for Out-of-The-Money options, as they have no intrinsic value, time value is the same as option price.

.

Wait for the final part 😀

.

OUR Websites:  http://www.smcindiaonline.com,http://www.smccapitals.com,http://www.smctradeonline.com
,http://www.smcwealth.com