Theta
Option buying is a veritable race against the clock. With each passing day,
the option loses theoretical value. Refer back to Exhibit 4.3 . When three
weeks pass and the time to expiration decreases from 44 days to 23, what
happens to the call value? If the stock price stays around its original level,
theta will be responsible for a loss of about 30 percent of the premium. If
Disney is at $35 with 23 days to expiration, the call will be worth $0.73.
With a big enough move in either direction, however, theta matters much
less.
With 23 days to expiration and Disney at $39, there is only 0.12 of time
value—the premium paid over parity for the option. At that point, it is
almost all delta exposure. Similarly, if the Disney stock price falls after
three weeks to $33, the call will have only 0.10 of time value. Time decay is
the least of Kim’s concerns if the stock makes a big move.