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Finance: What are Theta and Theta Decay? 10 Views


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Description:

Theta refers to either the amount of time left on a contract, or the sorority girl asking if you want to come to her mixer. The answer will always be no, Jen.

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Transcript

00:00

finance a la shmoop what are they two and theta decay well in Wall Street

00:08

parlance theta is just time you know parsley sage rosemary and our nevermind [Parsley, sage and rosemary plants appear]

00:14

okay this is time like with a calendar the tea there in theta

00:19

it stands for time or tick-tock and in this case theta refers to the amount of

00:25

time left on a contract as that contract gets closer to expiring or executing [Timeline of contract expiration date]

00:32

well you'd say that the theta decays like a molding old skeleton returning [Decayed skeleton appears in grave]

00:37

ashes to ashes dust to dust so yeah when theta decays the amount of

00:42

time left on a contract a trade the life of a stock option lessons most commonly

00:49

theta decay is applied to the time remaining on stock option contracts

00:53

well what theta is it yep example theta all right so let's say you paid five

00:57

bucks a share for a call option to buy Comcast shares for 40 bucks a share [Call option for comcast appears]

01:02

anytime in the next four and a half months the stock trades today at $34 a

01:06

share well if the stock were still at thirty four bucks a share four months [Calendar months fall off the wall]

01:10

later ie with only two weeks or a ten trading days left well what would you

01:15

guess your call option to buy Comcast at forty bucks a share or six dollars above

01:21

where it's currently trading would be worth more than five bucks less you know

01:25

way less for that option to be worth anything positive the stock would have

01:30

to go above forty or appreciate seventeen and a half percent ish in ten

01:35

days and nobody would then pay an incremental five bucks above that figure [Cash thrown onto a fire]

01:39

to then buy the shares for an all-in cost of forty five bucks trying to make

01:44

money like the stock would have to zoom from 34 to fifty bucks a share to really [Man holding comcast stock]

01:49

have a good outcome risk adjusted so as the option got closer to expiring its [Call option moves to expiration date]

01:54

value would decay because the optionality got less there's less time

01:59

for that stock to break fifty bucks and change if there were a thousand trading

02:04

days in the future and the option had notionally like five years before it

02:09

expired like enormous theta well then it would likely have sold for

02:13

vastly more than five bucks a share you know for that stock option and hey if [Piles of cash appear on table]

02:17

you want to see real decay well just check out Simon and Garfunkel lately

02:21

looks like they're you know homeward bound [Man discussing Simon and Garfunkel]

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