Friend or Foe?
Theta can be a good thing or a bad thing, depending on the position. Theta
hurts long option positions; whereas it helps short option positions. Take an
80-strike call with a theoretical value of 3.16 on a stock at $82 a share. The
32-day 80 call has a theta of 0.03. If a trader owned one of these calls, the
trader’s position would theoretically lose 0.03, or $0.03, as the time until
expiration change from 32 to 31 days. This trader has a negative theta
position. A trader short one of these calls would have an overnight
theoretical profit of $0.03 attributed to theta. This trader would have a
positive theta.
Theta affects put traders as well. Using all the same modeling inputs, the
32-day 80-strike put would have a theta of 0.02. A put holder would
theoretically lose $0.02 a day, and a put writer would theoretically make
$0.02. Long options carry with them negative theta; short options carry
positive theta.
A higher theta for the call than for the put of the same strike price is
common when an interest rate greater than zero is used in the pricing
model. As will be discussed in greater detail in the section on rho, interest
causes the time value of the call to be higher than that of the corresponding
put. At expiration, there is no time value left in either option. Because the
call begins with more time value, its premium must decline at a faster rate
than that of the put. Most modeling software will attribute the disparate
rates of decline in value all to theta, whereas some modeling interfaces will
make clear the distinction between the effect of time decay and the effect of
interest on the put-call pair.