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The Skinny on Options: Abstract Applications

Theta's Non-Linearity

The Skinny on Options: Abstract Applications

Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.

Theta represents one of the primary, non-directional ways that we like to position our portfolios to be profitable. By selling OTM options, we capture positive theta and are able to benefit from the simple passage of time. However, it is important to note that theta itself is not a linear function over time. In other words, the "value" of each of those days that do pass moves and changes, as we approach expiration.

In this Skinny, we take a look at the mathematical formula for theta, in an effort to better understand this non-linearity - specifically, its concavity. What we find is the radical that is front and center in the theta equation hints at the fact that its graphical relationship over time will indeed be either concave or convex in nature.

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