To analyze the impact of time decay (theta) on options pricing, you need to understand that as time passes, the value of an options contract naturally decreases if all other factors remain constant. This is called "theta decay". It affects options sellers positively and options buyers negatively. The closer an option gets to its expiration date, the faster it loses value due to time decay.

What Is Time Decay (Theta) in Options?

Time decay, also known as theta, is the rate at which the price of an options contract decreases as the expiration date approaches. It’s a key component in options trading. Theta shows how much value an option will lose each day if everything else remains unchanged. For buyers, it means the value goes down over time, and for sellers, it works in their favor.

How Does Theta Affect Options Pricing?

Theta directly impacts an option's premium. Every day, an out-of-the-money option will lose a portion of its value due to theta. This effect accelerates in the final few weeks before expiry. If you’re holding an option, this decay works against you. But if you’re selling options, theta becomes your friend, as you profit from this daily decline in premium.

Why Does Time Decay Accelerate Near Expiry?

As expiry nears, there's less time for the market to move in favor of the option buyer. This increases the risk for buyers and reduces the value of the option rapidly. This rapid drop in value is known as "accelerated time decay", and it's most noticeable in the final week before expiry. That’s why many traders prefer to sell options with less than 10 days left.

How Can You Calculate Theta in Real Trades?

Theta values are usually provided by most trading platforms. For example, if a call option has a theta of -0.05, it means the option will lose ₹5 per day (per lot) due to time decay. You can monitor this in real-time on platforms like Angel One to decide when to enter or exit trades, especially if you're trading weekly options.

Should You Buy or Sell Options in High Theta Periods?

If you're a buyer, it’s better to avoid buying options close to expiry because theta eats away at your premium quickly. On the other hand, if you’re a seller, short-term options can offer high theta decay, which means higher profits from premium erosion. Many experienced Indian traders use theta to create income through strategies like short straddles or iron condors.

How Can Retail Investors Use Theta in Their Strategy?

Retail investors in India can use theta to their advantage by learning to sell options rather than just buying them. Theta-based strategies help generate consistent income, especially in a sideways market. However, it’s important to manage risk with stop-losses or hedged positions to avoid big losses from sudden moves.