like a melting ice cube the longer you hold it, the faster it erodes Theta is one of the

easiest Greeks to understand. There are few certainties in l ife and even fewer in trading. One certainty is that time will pass. Like it or no t, tomorrow will come, ready or not. Theta measures your risk of an option s daily loss as time passes, also known as your time decay risk. Theta is defined as th e sensitivity of an option s price to each calendar day that passes, or the erosio n of an option s Extrinsic premium over time. (Extrinsic is a column choice on thin korswim Trade tab.) Yes, time decay erosion includes market days as well as weeke nds and holidays. For this reason, Theta can either increase or decrease the pro bability of your strategy expiring in- or out-of-the-money depending on whether Thet a is positive (benefit from time decay) or negative (hindered by time decay). A s you read in our other articles, Delta is defined as a measure of an option s sen sitivity to changes in underlying asset s price and applies to all traders. However theta is a measurement of time and only applies to option traders. Measuring a nd Managing Time [Decay] Risk A positive number in the Theta column on the Monitor tab of the thinkorswim platform is an option-specific position in your account that benefits or gains decay value every day that time passes. Conversely, a neg ative number in the Theta column is an option-specific position in your account th at loses decay value every day that time passes. So then does positive Theta gu arantee a profitable position? Does negative Theta guarantee a negative position? No. IMPORTANT REMINDER: Remember, net P/L is the combined result of the profit and loss for each Greek in a position. It is common for some of the Greeks in a p osition to benefit and other Greeks in a position to show a loss. Therefore, net profit or loss on a position depends on whether the Greeks working for you outwe igh the Greeks working against you. (The last article in this Alpha-Greek series will be Putting it All Together: A Delectable Combination and will cover more on h ow to use the Greeks in combination.) Positive Theta = benefits from every day that passes which helps to offset losses on other Greeks, enhance gains, or both . Negative Theta = loses value in time every day that passes which deepens loss on other Greeks, reduces gain, or both. Probability and Theta What does it mea n to a trader when selecting between a negative Theta strategy (such as a bullis h long call) versus a positive Theta strategy (such as bullish short out-of-themoney put vertical)? Both are bullish positive Delta and both are risk-defined, making them appear equal to the untrained or inexperienced trader. Both are bullish positive Delta and both are risk-defined, making them appear eq ual to the untrained or inexperienced trader. The trained or experienced trader however, looks at the entire Greek profile and also the break-even for each str ategy and notices that the negative Theta choice has a low probability of touchi ng and the positive Theta choice has a higher probability of touching. What does the trader see in each strategy that reveals said probability? Let s look at the Greek profile and break-even for each: Example A Long call @ 1.50 debit/cost (d ebit/costs = max loss $150 + transaction costs)** Theta would most likely be a n egative number Example B Short OTM 34/36 strike put Vertical @ (0.50) credit (2 -wide Vertical minus credit received = max loss $150 + transaction costs)** Thet a would most likely be a positive number max risk of $150 plus transaction cost s** for either strategy in this example Delta is the same positive amount for ei ther strategy in this example After reading the last article in the Alpha-Greek Soup series it may have left you wondering if all Deltas are created equal. In the above comparison, both trades have same delta and the same max loss, exclud ing transaction costs.** The difference is positive Theta for example B and negat ive theta for example A. How does this affect each of the example strategies? E xample A, with the Theta negative strategy, has a lower probability simply becau se the underlying stock must move enough to overcome the daily loss to time deca y (negative Theta) just to break-even and much more than that to show a profitab le number on your Monitor tab. Example B, with the Theta positive strategy, has a higher probability because gains from the daily time decay (positive Theta) cre ate a greater cushion of time decay benefits with each calendar day that passes. Be cause of the cushion created by daily time decay, the underlying stock can stay still or move slightly against you to reach the break-even; in some cases it is possible to realize a profitable number on your Monitor tab whether the underlying

stock moves or not. Make sense? Open your thinkorswim platform, navigate to t he Analyze tab and enter both strategies as simulated trades. Be sure to enter a si mulated long call and a simulated short out-of-the-money put Vertical that show similar Deltas and similar max losses for each. Make sense? Open your thinkorswim platform, navigate to the Analyze tab and enter both strategies as simulated trades. Be sure to enter a simulated long call and a simulated short out-of-the-money put Vertical that show similar Deltas and sim ilar max losses for each. Now click on the lower right date and begin advancing the date forward one day at a time over several days or weeks. Do this on each of the two simulated trades, one trade at a time. What do you notice between the theoretical P/L of each simulated trade??? What else did you notice in your Ana lyze tab experiment? The closer lower right date got to expiration, the larger Theta number became and the faster P/L changed due to increased Theta when appro aching expiration. Excellent! Does this mean a trader can enter positive Theta po sitions a few days before expiration and safely capitalize on the accelerating T heta as the options approach faster time decay erosion??? NO!!! Remember tradin g is all about risk versus potential reward. As an option nears expiration the pr emium gets smaller and smaller, so although per day Theta number increases, the amount of premium left to decay may be tiny. Is there a window where time decay has begun to accelerate, yet the remaining Extrinsic premium left to decay is l arge enough to warrant the risk? Some say Yes. One popular example of that window is approximately 25-55 calendar days before expiration. For this reason some trader s choose to enter their positive Theta positions within the 25-55 day window the n if they are not already out of the trade for other reasons, will then commonly exit the positive Theta positions approximately 4-10 calendar days before expir ation. Why 4-10 calendar days and not the last 1-2 days, or carry the position into expiration??? Here are several considerations that lead some traders to ex it expiring options in the 4-10 day window (in no particular order): Remaining E xtrinsic or time premium may be too small to warrant risk of continuing to hold the position If the position is near potential max gain, the risk vs. reward scen ario may now be against the trader (tiny further potential reward with large ris k original risk + risk of losing profit) Remove Expiration risk by exiting expiri ng positions (holding a risk-defined option position into expiration can lead to an unlimited risk situation) Depending on the underlying symbol, remove or reduc e dividend risk by closing expiring positions (if symbol goes x-div right before expiration) Free-up margin capital for next month s positions by exiting positions about to expire During the Thursday and Friday of an expiration week, many expir ing options may experience a widening of the Bid/Ask spread (think higher transa ction costs commission + Bid/Ask slippage to exit expiring positions too close t o expiration) Finding Positive Theta Trades The Analyze tab on the thinkorswim pl atform can be an asset in searching for potential positive Theta trade choices. G o to the Add Simulated Trades sub-tab found on the Analyze tab and enter in simulate d option trades on strategies that are familiar to you. Then un-check All, and chec k each simulated trade, one at a time. Look at the number under Theta on the middle LIVE price slice section. If the Theta number for a simulated trade is positive, that trade would benefit from time decay. Finding Positive Theta Trades The Analyze tab on the thinkorswim platform can be an asset in searching for potential positive Theta trade choices. Go to the Add Si mulated Trades sub-tab found on the Analyze tab and enter in simulated option trade s on strategies that are familiar to you. Then un-check All, and check each simulat ed trade, one at a time. Look at the number under Theta on the middle LIVE price sl ice section. If the Theta number for a simulated trade is positive, that trade wo uld benefit from time decay. If you are a chart reader, use the Risk Profile su b-tab to view your simulated trade on a chart as a filter for determining the pl ausibility of entering into the position or not. Final note: is there a Greek th at has an impact on the amount of Theta for or against you? Yes. Watch for the nex t article in the Alpha-Greek Soup series to learn more about the next Greek in t he series. Consistency is key - always follow your trading plan, Cindy Faber * IMPORTANT: Probability of a strategy aka Probability of Success is NOT the proba bility of realizing a profit. It is the probability of reaching break-even (neith

er gain nor loss other than transaction costs) or better. In other words, Probabil ity of Success is better worded as Probability of not losing more than transaction costs. Probability analysis results are theoretical in nature, not guaranteed, an d do not reflect any degree of certainty of an event occurring. A long call opt ion position places the entire cost of the option position at risk. Should an ind ividual long call position expire worthless, the entire cost of the position wou ld be lost. Spreads, Straddles, and other multiple-leg option strategies can en tail substantial transaction costs, including multiple commissions, which may im pact any potential return. These are advanced option strategies and often involve greater risk, and more complex risk, than basic options trades. Maximum potent ial reward for a credit spread (such as bullish short out-of-the-money put verti cal) is limited to the net premium received, less transaction costs. The maximum loss is the difference between strikes, less net premium received, plus transact ion costs **Transactions cost for trades placed online are $9.99 for stock orde rs, $9.99 for option orders plus a $0.75 fee per contract. Exercising an option p osition, and assignment of an options position, incur a $19.99 fee.