How Does Theta Decay Over the Weekend?

Options are financial contracts that provide the holder the right, but not the obligation, to buy or sell an underlying asset at a predetermined price by a specific date. These instruments derive their value from an underlying asset, such as a stock or an exchange-traded fund. A significant factor influencing an option’s value is the passage of time, a concept known as time decay.

Understanding Theta Decay

Theta, often referred to as time decay, is a measure of an option’s sensitivity to the passage of time. It quantifies the expected daily decrease in an option’s extrinsic value, which is the portion of its premium beyond its intrinsic value, assuming all other market factors remain constant. For options that are bought (long options), theta is typically a negative number, indicating that their value will diminish each day.

The rate at which an option loses value due to theta is not constant; it accelerates significantly as the option approaches its expiration date. This acceleration is particularly pronounced in the final 30 to 45 days before expiration, leading to a more rapid erosion of the option’s value. Options that are at-the-money (where the strike price is equal or very close to the underlying asset’s current price) tend to experience the highest rate of theta decay.

How Weekends Affect Theta Decay

Theta decay continues to occur over weekends and holidays, even when financial markets are closed. Options are contracts with a fixed expiration date, and every calendar day that passes brings the contract closer to that expiration, regardless of trading activity. Although the market price of the underlying asset and its implied volatility are not actively changing during non-trading hours, the time value component of the option’s premium still erodes.

Market participants, including professional traders and market makers, anticipate this continuous passage of time. They effectively “price in” the expected time decay for the weekend into the option’s value at the close of trading on Friday. The actual adjustment in the option’s price due to this time decay becomes apparent when the markets reopen on Monday. Option pricing models typically account for seven days of decay per week, not just the five trading days.

Considerations for Traders

The continuous nature of theta decay over weekends carries practical implications for options traders. For those holding long options, such as purchased calls or puts, maintaining these positions over a weekend can be disadvantageous. The time value of these options will continue to diminish, which can result in a loss of value by the time markets reopen. This effect is especially relevant for short-dated options, including weekly options, where the rate of decay is most significant.

Conversely, traders who have sold options (short calls or puts) may find the continuous theta decay over weekends to be favorable. As the time value of the sold options erodes, their value decreases, which can benefit the seller. Traders often adjust their strategies to account for this consistent decay, sometimes choosing to avoid holding long options over weekends or structuring trades to benefit from the time value erosion. It is important for traders to consider that other factors, such as unexpected news or events that occur over the weekend, can also influence option prices when markets reopen, potentially offsetting or amplifying the effects of time decay.