Compared to delta and gamma, theta is straightforward. Theta is the Greek traders use to measure the decline in an option's value due to time passing. Traders use the words "time-decay" or "decay" interchangeably with "theta."

Typically, traders measure theta in daily increments, but individuals could choose another timeframe if they desired. When speaking about an individual option, traders often talk about theta using the standard pricing-convention, or tick-size, for that option. In the grain and soybean markets, this usually means fractions-of-a-cent-per-day. So, it would be normal to hear a trader say something like, "There's an eighth of decay in those calls." Meaning, the trader's model estimates the daily-time-decay of the calls in question at about an eighth-of-a-cent each day.

Like delta and gamma, traders will often sum the theta measurements for individual options to estimate a portfolio's total theta. When doing so, traders usually convert the unit from ticks-per-day to dollars-per-day based on the quantity and dollar multipliers of the options in question. To differentiate whether they expect time to negatively or positively impact their portfolio, traders will often use the words "paying" or "collecting," respectively. So one might hear a trader say, "I'm paying five-grand-a-night." In this example, the trader expects the total theta of all the options in his portfolio to cost him around five-thousand dollars each day.

It is essential to understand that theta is a theoretical calculation and relies on all else being equal - which it never is. Theta is how much an option's owner can expect to lose and how much the writer can expect to make if nothing changes in the marketplace for the next twenty-four hours. Ultimately, the option prices we observe in the market reflect market participants' efforts to balance option decay and underlying movement. That brings us to the topic of option replication, which we will cover in a future article.

There are some reliable rules of thumb when it comes to theta. Option buyers pay theta, and option writers collect theta. Decay is not a straight line; it accelerates as expiration approaches. In general, short-term at-the-money options have the highest theta. The higher an option's implied volatility is, the higher its theta is.

Overall, theta is an essential tool for measuring risk. By understanding how time will impact a portfolio's value, traders can estimate the amount of underlying movement required to make the portfolio profitable. Theta can be useful for risk managers in other ways as well. Unlike some of the other Greeks, theta is comparable across products and portfolios. It is a tool we frequently use to make sure our Quartzite Precision Marketing client portfolios are well-balanced and similar. We will get more into the specifics of that in future articles. As always, we look forward to your questions and feedback. Thanks for taking the time to read.