Collecting theta

A

a529612

Is it true that theta decelerates for OTM options in the final 30 days?

http://www.themoneyblogs.com/optionsandvolatility/my.blog/what-you-didnt-know-about-time-decay-.html

thetaOTM.jpg
 
It is true, if you go far enough OTM.

Near the money, there's always a possibility that the stock will move far enough to affect the option. Even on the last day, it's possible for a stock to move a point or two. It's not likely, but you never know so there's still some premium left for theta to eat away at.

If you're sufficiently far OTM, the options will become completely worthless some time before expiration. If you have $50 stock with low volatility, nobody is going to pay anything at all for 10 points OTM. The reason there's no time decay is that there's nothing left to decay. Your biggest theta in that case would have been a couple weeks earlier, when the market collectively said "y'know, I really don't think that stock has 10 points left in it this month".
 
There's no hard and fast rule. As you go farther OTM, the graph progressively changes from the accelerating-decay one to the decelerating-decay one. How far OTM you have to go will depend on IV. Someone out there might be able to give you a rough idea of the delta of a bottom-graph option.

Here's an idea that just popped into my head. Maybe someone more expert on the greeks can fill in the gaps or tell me why I'm a crackpot. Take today's theta, and extrapolate linearly to expiration. Here are your two cases:

- If you'd end up with a negative-valued option (today's theta is fast enough to take the option to zero early) you're looking at the bottom graph. Theta will have to decelerate at some point, since the option premium can't go negative.
- If you'd end up with a positive-valued option (today's theta is not fast enough to take the option to zero early), you're looking at the top graph. Theta will have to accelerate at some point, because OTM options have to hit zero eventually.
 
Quote from IV_Trader:

a570938462987621083 , theta itself is worthless ; you should use gamma/theta ratio curve
More...

Could you explain this a little bit more please?
 
Quote from bigbiscuit:

Could you explain this a little bit more please?
More...

Fat gamma. Achieving a normalized ratio approaching parity. In most cases, $gammas are 2x $thetas [think atm option]. If atm gammas are low, thetas is high. It's synonymous with a +IV / RV ratio.
 
You must log in or register to reply here.
Back
Top