Since the market is only open 6.5 hours a day, will MMs discount nearly 24 hr worth of theta in 6.5 hours? (Minus some gap risk/overnight risk premium I would assume). I hear people say this all the time... However I ran the following experiment on Google Jun15'12 570C. The currently calculated time to expiration is now exactly 2.045133 days / 365 for annualization = 0.005603. Putting this into Black Scholes I get the exact price of the option that MMs quote right now, so I'm not seeing any discounting being done? And I'm not seeing any decline in IVs either. So how does this work?
That is good question but all theoretical and the answer won't help you in trading. My experience says that the price of the option decays as we get close to the market close if the volatility stays the same (most of the time it does not based on buying or selling pressure on the option itself). Another good observation is that how the option decays in the weekend? Does the option price decays just at close of Friday to reflect the decay of the weekend or it happens on Monday? My observation shows that it is a combination of both. Maybe 50/50. If we expect a volatile weekend, the decay happens on Monday morning but for quiet weekends, it happens mostly on Friday.