How Fast Your Option Melts - Courtesy www.TDAmeritrade.com

In an earlier post we talked about a most puzzling mystery.  That was when you buy a call option, and the underlying stock is moving up, but your option and its value may not be.  Or worse yet, your option may be going down.

We said that the culprit might be a Greek thing called Theta.

So all that said, what does this Theta thing have to do with it – you know, the one with the bodacious formula we looked at earlier – see An Options Murder Mystery – Theta The Greek Did It.

Well, you aren’t going to believe how easy this is.  Be sure you are sitting down before you read the next sentence.

Theta tells you how much money, in dollars and cents, your option value decays away per day.  In other words, how fast your ice cube melts in the sun.  That’s it.

Good to know, yes?  Isn’t this something to check when you are choosing options?

You bet it is.

And the information is sitting there right in front of you as you are picking your option on your online trading screen.  Let’s look at an example.  Here is the option chain for Microsoft May options as of March 31, 2012.

Let’s say you are thinking about buying the May options at a strike price of $33 a share.  You think it’s not a bad choice because Microsoft is currently trading at 32.24 a share, so it doesn’t have far to go to hit $33 a share.  And the option has 50 days before it expires.

So you look over at the Theta column which shows -0.008 (under the yellow arrow in the illustration).

What does that mean?

Well, since options are sold in lots of 100, multiply the .008 X 100 which gives you $.80.  The option, which will cost you $55, is decaying at a rate of $.80 per day — as of today.  It will probably decay at a faster rate in the future as time goes by.

Good to know, yes?

Now this isn’t the only factor you will use to pick the best option, but it is certainly one of them.

And by knowing about it, you have an advantage over many options traders out in the market.  Which is a good thing.  Because trading options is a zero sum game.  For every winner there is a loser.

And you want to be the winner.  Right?

So be sure and check that Theta thing before you put on an option trade.  It’s sitting there right in front of you.

To your health and prosperity – John