Theta is a term used in trading to measure the rate of decline in the value of an option caused by time passing. This is independent from the actual value of the underlying asset. The theory behind theta is that as the exercise date approaches, the value of the option declines as there is less likelihood of it moving a lot in price.
Theta is used to measure the risk associated with holding an option for a period of time, but in practice it is not that important as it does not take into account the asset price, so therefore is not used that often.
An example of theta would be:
- An option has a strike price of $50.00
- The theta of the option is 7.5
- Therefore, for every day that passes the value of the option should fall by $7.50