Theta Decay

Theta decay is the loss of an option’s time value as each day passes, holding everything else constant — measured by theta, the Greek that states how many rupees of premium an option sheds per day. An option’s price is intrinsic value plus time value; time value exists because more time means more chance of a favourable move, and it melts to zero by expiry. Decay is nonlinear: gentle when expiry is far away and steepest in the final days and hours, especially for at-the-money strikes.

Example

With NIFTY at 25,000, suppose the at-the-money 25,000 call with six days to expiry trades at ₹160 — all time value — with a theta of about −₹18 per day. If NIFTY stays put, the premium drifts toward roughly ₹142 by tomorrow; a seller of one lot (75) gains about 18 × 75 = ₹1,350 per quiet day, and a buyer loses the same. By the final day the remaining time value can evaporate within hours. Hypothetical figures — in practice, moves in the index and in implied volatility routinely overwhelm a single day’s theta.

Why it matters

Theta is the engine of every premium-selling system — straddles, strangles, iron condors — and the headwind against every option-buying strategy. Systematic traders design around its shape: sellers concentrate where decay is steepest (near expiry) while managing the gamma risk that spikes at the same time; buyers avoid holding decaying at-the-money premium through quiet sessions. The seller’s edge is not free money — it is payment for absorbing tail risk.

In INDfolio AI, options strategies are backtested with real premium histories, so decay’s effect is measured rather than assumed — see Options backtesting.