I like looking at lose pron from time to time. But, never understood how people lose money due to time decay in options.
In: Economics
Would you pay more for an OTM option if it expires now, or if it expires in ten years?
The closer you get to the expiration date, the less people will be willing to pay for the contract. Case in point: current price of a stock is $25/share. You have two contracts with a price of $30/share. One expires in a month, the other expires in two days. The one that’s still a month out is more valuable, since there’s more time for the stock price to pass that $30 mark.
Options contracts are written for a specific expiration date. If the option is still “out of the money” (current stock price is less favorable than the strike price, and therefore wouldn’t be profitable to exercise), the option will expire worthless, and the investor who held the option will have lost all they purchased it for.
Because the chances of a stock moving a large amount decrease as the expiration date nears, options tend to decrease in value even if the stock price stays relatively unchanged. The value in them earlier was purely speculation that such a move would occur.
People are more willing to buy an option that still has a lot of time left. Less time means less demand for your option which means less value which means less money.
You have an option that’s not in the money, and every day closer to expiration the likelihood of it ever becoming in the money goes down so the amount another buyer is willing to pay goes down.
Let’s say you have a $50 call that expires in 3 weeks, and the stock is currently trading at $45. That option has a greater chance of climbing above $50 than the same stock’s $50 call expiring that week, so buyers will pay more for the contract with a date further out. And when the 3 week contract only has a week until expiration in 2 weeks, it’ll be worth less than the same strike price contracts dated further out.
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