Can someone help with "decay" questions?

Discussion in 'Options' started by slapshot, Dec 27, 2005.

  1. Hello,

    Thanks in advance for any serious, well-intentioned help.

    I am a seasoned futures trader that has just made my first option trade ever - buying a futures option put for March 06 - so obviously I'm an options rookie, although I have read a couple of books to try to get the basics down.

    Right now, it is "at the money" and looking like it may turn out to be a dandy trade, especially after today's selloff.

    Here is my question - how much of a factor is time decay for an option that is at or in the money?

    I am aware that an significantly out of the money option will decrease rapidly as the strike date looms, as it becomes highly unlikely that it will ever get near "strike".

    But it seems to me that as I have watched the underlying asset, my put matches it almost tick per tick (which makes sense since it is in/at the money).

    So if it goes further in the money, how much do I need to be worried about time decay eating the value?

    In other words, if it is deep in the money, but it is still 2 months away from expiration, is decay actually even factored in or is it "valued" by the market exactly the same as the underlying due to intrinsic value? Or is there still some "premium" value there due to the remaining time?

    Thanks for any help, advice or pointing me in the right direction to learn about this concept.



    PS Any "must reads" for options? Simple stuff, please - I ain't that bright...
  2. Hey Paul -- all the greeks, save for delta, are greatest at the atm strike. So the greatest risks lie atm for theta.

    It's why atm straddles are considered by some to be the riskiest strategy; they offer little margin for error on both sides of the transaction.

    Sheldon Natenberg's "Option Volatility and Pricing" is considered the bible for exchange-traded vanilla options.

  3. HUH? (I don't get the "greeks" thing - could you elaborate?)

    (I got the part about the book - thanks)
  4. You'd see that thetas[decay] peak atm if you were looking at the distribution of theta with the x-axis denoting strikes and y-axis denoting magnitude, and the atm strike centered. It's a bell curve. Same for gamma; peaking atm and diminishing at the tails of the distro.

    ATM deltas are 50... the atm option will trade at half the magnitude of the spot-contract assuming static volatility.
  5. I should add the the gamma/theta curves exhibit kurtosis as time passes -- the curve becomes increasingly "peaky" [leptokurtic] at the center of the distro[atm strike] -- this corresponds to increased risk of atm options as time to expiration nears.

    An increase in option volatility tends to flatten the curvature, but the trend is always to "peakedness" or increased risk as time passes.
  6. Try the Larry McMillan books -- Options as a Strategic Investment and McMillan on Options. I'd try, they're usually cheaper than amazon (but they sell new books). Of course sometimes they don't have what you want.....
  7. cnms2


  8. zxcv1fu


  9. It will move roughly half the speed as the underlying asset if it is ATM. This is what delta is a measure of - how much your PUT will gain/lose value with respect to the underlying. ATM options have a delta of roughly .50.

    As the option goes more ITM the delta will tend towards 1.

    You can work out how much extrinsic value the option has by subtracting the intrinsic value i.e. how much ITM the option is. The extrinsic value is what will decay as time passes. So to answer your question, how much you should worry is dependent on how much of the extrinsic value you want to keep.

    See above. If it is deep ITM it will move roughly in line with the underlying - the options delta will tell you roughly how much - but there will be an additional extrinsic value that will waste away as expiration approaches.

  10. MoMoney,

    Thank you very much for the crystal clear reply and explanation - it was very helpful.

    Also thanks to others.

    I have been reading up on the Greeks and now somewhat get it.

    You are absolutely right about the .5 Delta (50% movement vs. underlying) I was watching it closely today, it is still very near ATM.

    I also get that if the PUT goes ITM significantly, the rate of change in the value will more closely match the underlying.

    If that happens, does the Theta decrease at a proportionate rate as Delta goes up?

    (as I understand it, the longer the price of underlying remains basically unchanged, the more that Theta eats at extrinsic value - am I getting this right?)

    Also, do you know of any good web sites where I can put in the symbol and view the current levels for the Greeks?


    #10     Dec 28, 2005