OPTIONS

Sunday, July 27, 2008

The Impacts of TIME REMAINING TO EXPIRATION on OPTIONS GREEKS: Summary

The Effect of Time Remaining To Expiration on DELTA
Delta
is a measure of the change in the option price resulting from a change in the underlying stock price.

An option’s Delta does change as one trading day passes. This is often called as “Delta Decay”.
As the expiration is nearing (time to expiration gets shorter), the time value portion of an option is declining (time decay effect).
This causes the delta of ITM (In-The-Money) options to increase (i.e. ITM option’s delta gets closer to 1 for Calls or to -1 for Puts) and the delta of OTM (Out-of-The-Money) options to decrease (i.e. OTM option’s delta gets closer to 0).

As a result:
For ITM options, for the same strike price, the longer days to expiration, the lower the delta. Hence, a next month ITM option will have a lower delta than the current month option.
On the other hand, for OTM options, for the same strike price, the longer days to expiration, the higher the delta. So, a next month OTM option will have higher delta than the current month option.

The Impact of Time Remaining to Expiration on THETA
As mentioned earlier, as the expiration is nearing (fewer days to expiration), the time value portion of an option will be declining due to “time decay” effect.
And Theta is a measure of the Time Decay, i.e. the rate of decline of option’s time-value resulting from the passage of time.

Theta (time decay) increases as an option gets closer to expiration.
Theta would increase sharply (resulting in time value decrease at an accelerating rate) in the last few weeks before expiration (particularly in the last 30 days before expiration). Therefore, this can severely undermine a long option holder's position.

However, please note here that Theta increase sharply (Time Value decreases at accelerating rate) as expiration nears is true only for ATM option.

For both ITM & OTM options, on the other hand, Theta decreases as an option is approaching expiration.
As a result, for both ITM & OTM options, Time Value actually decreases at a decelerating rate as expiration nears.


Please refer to “More Understanding about Options Time Value” for further discussion about this.

The Effect of Time Remaining to Expiration on VEGA
Vega
is a measure the sensitivity of an option’s price to changes in Implied Volatility (IV).
Assuming all other things unchanged, Vega decrease as an option gets closer to expiration.

Vega is higher when there is more time remaining to expiration. This makes sense because options with more time remaining to expiration have larger portion of time value, and it is the time value that is affected by changes in volatility.

Related Posts:
* Option Greek
* Options Trading Basic – Part 1
* Options Trading Basic – Part 2
* Understanding Implied Volatility (IV)
* Learning Candlestick Charts
* FREE Trading Educational Videos You Should Not Miss

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