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Definition of 'Theta'

Theta measures the rate of devaluation of the price of an option due to the passing of time.

When comparing an option to a stock you realize that a stock you can own for ever (assuming the company remains in its current form forever). On the other hand an option you only own for a short period of time. Time is therefore a factor in the valuation of an option which does not apply to a stock. Theta is the method used to measure the rate of decline of the option's price with respect to time.

Option traders also refer to Theta as the time decay of value of an option.

This time decay concept is an important concept for writers of options. These traders are expecting to make money by selling something which devalues over time. For this reason they expect the price of the underlying security to remain relatively stagnant and the value to decrease because of time decay.

The trader who buys an option, on the other hand, is expecting volatility to kick in and the price to move by a greater value than the "time value" that he/she has purchased.

All the Greeks: Delta, Gamma, Vega, Theta, Vomma

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