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Wednesday, September 06, 2006 8:37:47 AM
Understanding Theta IV
Brian Overby
July 10, 2006
In the last post of our Theta series, I’d like to show you how to evaluate theta across your entire portfolio. TradeKing makes it easy with our automatic calculations on the Holdings page.
It’s not only useful to look at theta on individual options; you should consider your net theta across your entire portfolio. If you are net long options in your account your portfolio will have a negative theta. In other words, for each day that passes you will be suffering a bit from time decay. If you are net short options in your account your portfolio will have positive theta, which means your account will gain value with each day that passes.
To calculate your portfolio theta, take the theta for each option contact in the portfolio and multiply it by the number of contracts and the number of shares at a dollar value of $1. Let’s say you’re holding 20 contracts of an option with a theta value of -.085. Multiply 20 contracts x $100 per contact x by theta -.085 to get a position theta of -170. This means that each day that passes this position will lose $170 due to time decay. You would do this for each position in the account.
Don’t sweat all this math. TradeKing does all these calculations for you automatically, so the theta for each of our positions, plus the portfolio’s net theta, is always available. Go to the Accounts menu, choose Holdings, then click the Options View tab.
By totaling the theta column, we can net out all the individual position thetas for the entire portfolio. In this example, the account will theoretically lose $1,417.76 because of erosion of time premium for each day that passes. Keep in mind when we talk about theta, we’re only talking about gains or losses due to time passing. Many other factors beyond simple time decay can also affect your ultimate gains or losses: price swings on the underlying security, an increase or decrease in volatility, or a change in carry costs.
Understanding theta should help you manage the affect of time on your options holdings – hopefully to your best advantage. Next stop Vega.
Brian Overby
July 10, 2006
In the last post of our Theta series, I’d like to show you how to evaluate theta across your entire portfolio. TradeKing makes it easy with our automatic calculations on the Holdings page.
It’s not only useful to look at theta on individual options; you should consider your net theta across your entire portfolio. If you are net long options in your account your portfolio will have a negative theta. In other words, for each day that passes you will be suffering a bit from time decay. If you are net short options in your account your portfolio will have positive theta, which means your account will gain value with each day that passes.
To calculate your portfolio theta, take the theta for each option contact in the portfolio and multiply it by the number of contracts and the number of shares at a dollar value of $1. Let’s say you’re holding 20 contracts of an option with a theta value of -.085. Multiply 20 contracts x $100 per contact x by theta -.085 to get a position theta of -170. This means that each day that passes this position will lose $170 due to time decay. You would do this for each position in the account.
Don’t sweat all this math. TradeKing does all these calculations for you automatically, so the theta for each of our positions, plus the portfolio’s net theta, is always available. Go to the Accounts menu, choose Holdings, then click the Options View tab.
By totaling the theta column, we can net out all the individual position thetas for the entire portfolio. In this example, the account will theoretically lose $1,417.76 because of erosion of time premium for each day that passes. Keep in mind when we talk about theta, we’re only talking about gains or losses due to time passing. Many other factors beyond simple time decay can also affect your ultimate gains or losses: price swings on the underlying security, an increase or decrease in volatility, or a change in carry costs.
Understanding theta should help you manage the affect of time on your options holdings – hopefully to your best advantage. Next stop Vega.
invest at your own risk, based on your own due diligence, at your own risk tolerance
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