Does time decay happen in days or minutes in options?

Question

I am wondering how time decay is calculated. I am thinking it takes at least a day to time decay the value of an option.

Answer 1

Time decay is a continuous process. A very small amount of an options "fair value" is lost due to time decay every second. However, since options are never traded with fractions of pennies you have to wait for the amount of value lost to add up to the minimum increment for bid prices, be it $0.01, $0.05, or $0.10 for the option price to change.

The usual metric used to calculate time decay, theta, is the amount of price will decay in one 24-hour day. There are, however, times prices change in less than a day due to time decay. I can give you two examples.

(1) When the Monday before the third Friday of the month is a holiday, market makers will frequently slowly drop the value of the nearest-term options throughout the day on the second Friday of the month to reduce the gap in the price due to time decay between Friday's close and Tuesday's open.

(2) I once sold some options at 3:45 Eastern Time on the third Friday of the month for $0.05 per share. Fifteen minutes later those options were worthless because of the rapid time decay just before expiration. (Note Well: Selling options for $0.05 per share is a terrible practice and I strongly advise against doing it.)

Answer 2

Time decay happens in days - including weekends and on days when the market is closed - even Christmas.

The greatest or most severe time decay happens in the last 3 weeks to 6 weeks of the option's time period.

It all goes by the Black-Scholls formula. Its very confusing. BUT that's why those men won the Nobel prize AND why there's such a wide time difference. There's PLENTY of "elbow room".

Thanks for asking your Q! I enjoyed answering it!

VTY,
Ron Berue

Yes, that is my real last name!