Time decay
The loss of an option's value as expiry approaches, other things equal, measured by theta. It usually works against the holder of an option and in favour of the writer.
Where you will meet it
Time decay appears in 4 learning outcomes on the CFA syllabus. A few of them:
- Explain what each option Greek measures
“Theta, the response to the passage of time, is usually negative for a long option, so time decay favours the writer.”
- Assess the likely return from a yield curve strategy and the risks it carries
“Risks include the rate view being wrong, an unexpected curve shape, leverage and time decay on any options used.”
- Explain what calendar spreads are used for
“Calendars trade time decay, express views on the volatility term structure, and position around a known event falling between the expiries.”
- Explain why gamma risk matters when trading options
“Long gamma positions gain from large moves but pay for this through time decay.”
See also
Practise it
Practise time decay until it is automatic: questions that explain every wrong option.
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