Binomial Tree

finance a la shmoop what are they two and theta decay well in Wall Street

parlance theta is just time you know parsley sage rosemary and our nevermind [Parsley, sage and rosemary plants appear]

okay this is time like with a calendar the tea there in theta

it stands for time or tick-tock and in this case theta refers to the amount of

time left on a contract as that contract gets closer to expiring or executing [Timeline of contract expiration date]

well you'd say that the theta decays like a molding old skeleton returning [Decayed skeleton appears in grave]

ashes to ashes dust to dust so yeah when theta decays the amount of

time left on a contract a trade the life of a stock option lessons most commonly

theta decay is applied to the time remaining on stock option contracts

well what theta is it yep example theta all right so let's say you paid five

bucks a share for a call option to buy Comcast shares for 40 bucks a share [Call option for comcast appears]

anytime in the next four and a half months the stock trades today at $34 a

share well if the stock were still at thirty four bucks a share four months [Calendar months fall off the wall]

later ie with only two weeks or a ten trading days left well what would you

guess your call option to buy Comcast at forty bucks a share or six dollars above

where it's currently trading would be worth more than five bucks less you know

way less for that option to be worth anything positive the stock would have

to go above forty or appreciate seventeen and a half percent ish in ten

days and nobody would then pay an incremental five bucks above that figure [Cash thrown onto a fire]

to then buy the shares for an all-in cost of forty five bucks trying to make

money like the stock would have to zoom from 34 to fifty bucks a share to really [Man holding comcast stock]

have a good outcome risk adjusted so as the option got closer to expiring its [Call option moves to expiration date]

value would decay because the optionality got less there's less time

for that stock to break fifty bucks and change if there were a thousand trading

days in the future and the option had notionally like five years before it

expired like enormous theta well then it would likely have sold for

vastly more than five bucks a share you know for that stock option and hey if [Piles of cash appear on table]

you want to see real decay well just check out Simon and Garfunkel lately

looks like they're you know homeward bound [Man discussing Simon and Garfunkel]