Know your options: Time value

Options 101: Time value

It is often said that time is of the essence. That is particularly true when it comes to valuing and trading options.

An option on a stock represents the right to buy or sell that stock for a specific price within a given time frame. If the stock winds up outside of the profitable zone set up by the option's buyer, then the option expires worthless, and the trader has lost the premium paid.

It naturally follows that the longer until the option expires, the greater the chance that the position becomes profitable or becomes more profitable, and thus the more value the option will have. Conversely, as time ticks away and the option's expiration draws nearer, that option will lose value, all else being equal. This is often known as "time decay."

But just how much value will the option tend to lose as time passes? That question is answered by a crucial options measure known as "theta."