Quick question on Theta

A

athlonmank8

I don't know if i've been calculating it wrong all this time or not but Theta has no direct correlation to price change correct?

For example.

Option trading @ $1.00 and strike is $10.

Underlying price moves $5.

Delta: .1
Theta: .05

If price moves $5 in 1 day calculation would be....

Delta*5 =.50
Theta 1*-.05 = -.05

Price 1+.50-.05 = $1.45 after day 1.

I saw someone price it like this.....

$1.00 + .50

then they priced theta by the price change -.05*$5*1 day = -.25

1+.50-.25 = $1.25

But that's not correct is it?


Refer to this thread bottom of page #3.

http://www.elitetrader.com/vb/showthread.php?s=&threadid=124448&perpage=6&pagenumber=2
 
I must apologize it was my mistake. When I made the original post it was late and I did the calculations in a hurry. Then when I reposted it did not double check my math. Here is how it should have been written:

It would depend largely on how long the underlying took to reach that $5 move. If it did it in 1 day and the option had a Delta of .1 and a Theta of -.05 then the value of the option the next day would only be $1.45.

If the stock took 3 days to move that $5 with a Delta of .1 and a Theta of -.05 then the options value would only be about $1.35.

Adding in the effects of Gamma to the 3 day example, the option value might end up anywhere between $1.85 (assuming Gamma of .02) and $2.85 (assuming Gamma of .06).
More...

I think what I did that night was subtracted the Theta from the Delta instead of the option price. In other words 0.1 - 0.05 = .05 then multiplied the result by the $5 to get the .25 improvement making the option price 1.25 instead of multiplying the delta by price $5 *.1 = .50 then subtracting the Theta of .05 to get the .45 price improvement which is correct.

Gamma is harder to calc in because if the stock price jumped $4 on the first day, stayed the same the second day then rose $1 on the last day the cal would be completely different than if it stayed the same the first 2 day then made the whole $5 movement on the last day. Also just b/c the option has a Gamma of .4 today that might change tomorrow and affect the outcome.

This example also assumes that Theta is not accelerating over the 3 day period.
 
Thanks Maverickz. I apologize for taking it to a thread. I know you know your stuff, so when I saw your post I couldn't figure out what the hell I was doing wrong. haha

Thanks again bud. I appreciate the response and the info.
 
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