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How does time decay affect option price?

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Ankit Singh
Option Writing & Investments

Time Decay leads to a steady fall in option prices, but the rate of it depends on various factors (whether the option is in the money or out of the money, time left for expiration etc) , it is an option writer's best friend in a sideways market.

Hi Ashish, the price of an option comprises of two components: intrinsic value and extrinsic value (aka time value). Time decay affects the extrinsic value of an option. The greater the time to time expiration, the greater would be the extrinsic value of an option and the greater would be the decay because of passage of time. Also note that the time decay would be slow when there are a lot of days to expiration. However, as the number of days reduces, the impact of time decay will become greater, before starting to accelerate as the expiry gets closer. To understand this, see the hypothetical chart below:

How does time decay affect option price?

Remember, time decay is the buyer's enemy and the seller's friend.

We have written extensively about this in the Options module on School of Stocks. We have also extensively spoken about the Option Greek that can be used to gauge the impact of time on the price of an option. To read more, click here16 and here14.