Options are derivatives securities, and boil down to a contract issuing the rights to its purchaser/owner to buy or sell an asset within a predetermined timeframe. As a security, options are subject to their own terms and conditions and are categorised into two types; ‘call’ and ‘put’.
Call options give owners the right to buy an asset at a determined price within a specific time, whereas put options allow the owner to sell at a certain price within a given timeframe.
Options can be bought or sold with multiple expiration dates because, unlike when you purchase shares in stock, options typically serve as a shorter-to-mid-term investment. If you watch the price of options as they get closer to their expiration date, you’ll notice the price falls in line with the impending expiration. This correlation is called theta, or time decay, and represents the continuous devaluation of an option’s value. For example, if an option has a theta value of of -0.05, the current value of that option will decrease by a value of £0.05 each day until its eventual expiration.
Theta is an important value to know about because, depending on whether you are long or short, your position will either strengthen or weaken. So, if you are short an option, the theta value will be positive, meaning you stand to profit from fewer days until the expiration date. If you are short an option, on the other hand, the theta value will be negative, meaning you stand to lose out on fewer days until the expiration date.
