20 lines
1.2 KiB
Plaintext
20 lines
1.2 KiB
Plaintext
The Effects of Volatility and Time on
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Theta
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Stock price is not the only factor that affects theta values. Volatility and
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time to expiration come into play here as well. The volatility input to the
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pricing model has a direct relationship to option values. The higher the
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volatility, the higher the value of the option. Higher-valued options decay at
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a faster rate than lower-valued options—they have to; their time values will
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both be zero at expiration. All else held constant, the higher the volatility
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assumption, the higher the theta.
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The days to expiration have a direct relationship to option values as well.
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As the number of days to expiration decreases, the rate at which an option
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decays may change, depending on the relationship of the stock price to the
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strike price. ATM options tend to decay at a nonlinear rate—that is, they
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lose value faster as expiration approaches—whereas the time values of ITM
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and OTM options decay at a steadier rate.
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Consider a hypothetical stock trading at $70 a share. Exhibit 2.11 shows
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how the theoretical values of the 75-strike call and the 70-strike call decline
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with the passage of time, holding all other parameters constant.
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EXHIBIT 2.11 Rate of decay: ATM vs. OTM.
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