Options involve risk and are not suitable for all investors. Certain requirements must be met to trade options. Before engaging in the purchase or sale of options, investors should understand the nature of and extent of their rights and obligations and be aware of the risks involved in investing with options. Please read the options disclosure document titled "Characteristics and Risks of Standardized Options (PDF)" before considering any option transaction. You may also call the Investment Center at 877.653.4732 for a copy. A separate client agreement is needed. Multi-leg option orders are charged one base commission per order, plus a per-contract charge.
The maximum loss, gain and breakeven of any options strategy only remains as defined so long as the strategy contains all original positions. Trading, rolling, assignment, or exercise of any portion of the strategy will result in a new maximum loss, gain and breakeven calculation, which will be materially different from the calculation when the strategy remains intact with all of the contemplated legs or positions. This is applicable to all options strategies inclusive of long options, short options and spreads. To learn more about Merrill's uncovered option handling practices, view
Naked Option Stress Analysis (NOSA) (PDF).
Early assignment risk is always present for option writers (specific to American-style options only). Early assignment risk may be amplified in the event a call writer is short an option during the period the underlying security has an ex-dividend date. This is referred to as dividend risk.
Long options are exercised and short options are assigned. Note that American-style options can be assigned/exercised at any time through the day of expiration without prior notice. Options can be assigned/exercised after market close on expiration day. View specific
Merrill Option Exercise & Assignment Practices (PDF).
Supporting documentation for any claims, comparison, recommendations, statistics, or other technical data, will be supplied upon request.
Please read the options disclosure document (PDF)
What is Theta?
Theta represents, in theory, how much an option's premium may decay each day with all other factors remaining the same.
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The amount of the option premium that is attributable to the amount of time remaining until the expiration of the option contract.
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An option is near the money when the strike price is relatively close to the market price.
For illustrative purposes only.
Higher Theta is an indication that the value of the option will decay more rapidly over time. Theta is typically higher for short-dated options, especially near-the-money, as there is more urgency for the underlying to move in the money before expiration.
Theta is a negative value for long (purchased) positions and a positive value for short (sold) positions – regardless if the contract is a call or a put.
How is Theta used?
Long Options and Theta
A long option holder is negative Theta, which equates to buying time. Since time is always depleting, a long option holder needs to capture the time purchased prior to the option expiring and/or experience a movement in the underlying greater than the amount of Theta purchased. Meaning – holding an option to expiration is only profitable if the underlying moves greater than the Theta purchased. Otherwise, Theta can be captured by closing the option prior to expiration.
For Example, if XYZ is trading at $100.00 and a XYZ $100.00 Call is purchased at $3.00, the premium is primarily time value as executing on the contract is not more favorable than the market. If XYZ remains at $100.00 at expiration, the call will expire worthless. The buyer of the XYZ $100.00 Call will lose all of the premium purchased since time is up. If XYZ was at $105.00 on expiration, the XYZ $100.00 Call will now be worth at least $5.00 as the contract is more favorable than the market (buy at the strike, $100.00 and sell at the market, $105.00). However, the purchaser of the XYZ $100.00 Call will capture $2.00 of profit in this scenario as time value has completely decayed. The loss in this scenario is limited to the premium paid and has unlimited reward potential.
Negative Theta typically means time is not of favor however, the risk is limited to potentially make a higher reward.
For illustrative purposes only. Buyer Beware:
Since options are decaying in value, time favors the seller. The buyer needs extreme price movement to tip the scales.
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Selling a call option contract to establish a new position.
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Selling a put option contract to establish a new position.
For Example, if XYZ is trading at $100.00 and a XYZ $100.00 Call is sold at $3.00, the premium is primarily time value as executing on the contract is not more favorable than the market. If XYZ remains at $100.00 at expiration, the call will expire worthless. The seller of the XYZ $100.00 Call will keep all of the premium sold since time is up. If XYZ was at $105.00 on expiration, the XYZ $100.00 Call will now be worth at least $5.00 as the contract is more favorable than the market (buy at the strike, $100.00 and sell at the market, $105.00). However, the seller of the XYZ $100.00 Call will incur a loss of $2.00 in this scenario as time value has completely decayed. The loss in this scenario has unlimited potential and the reward is limited to the premium sold.
Positive Theta typically means time is of favor however, the reward is limited with increased risk potential.
What are other factors to consider?
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A call option is out of the money if the strike price is greater than the market price of the underlying security. A put option is out of the money if the strike price is less than the market price of the underlying security.
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A call option is in the money if the strike price is less than the market price of the underlying security. A put option is in-the-money if the strike price is greater than the market price of the underlying security.
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A call option is in the money if the strike price is less than the market price of the underlying security. A put option is in-the-money if the strike price is greater than the market price of the underlying security.
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The amount by which an option total premium exceeds its intrinsic value.
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The market's forecast of a likely movement in the underlying security.