Option Time Value Deterioration (Theta)

Since options have a specific life span, it makes sense that their values change throughout that period of time. Option Theta tells you the extrinsic value or how much an option changes (loses) each day before its expiration date. Thus, Theta is the estimation of how much of the option’s value has decreased for any specific day it is being traded. Since Theta has a negative influence on an option’s value, it is always represented as a negative value. Assume that you have an option with a value of 3.25 and a corresponding Theta of –0.25. You can then expect that tomorrow the option’s value will decline to 3.00 (i.e. 3.25-0.25). As long as the underlying asset’s price opens at the same price as the previous closing price. This graph shows what happens to an out-of-the-money Call option as it continues toward its expiration date. The amount the option’s value declines each day is ultimately what Theta determines. As the expiration date becomes closer, the option’s value declines at a faster rate. Notice the highlighted area, which represents the last 30 days of the option’s life. This is when the theta is eroding the value of the option at its fastest rate as demonstrated below in this graph.

A trade idea that will take advantage of option value deterioration (theta).
S&P 500 (SPY) Iron Condor Trade Example:
Buy to open: December 115.00 strike calls (FYNLK)
Sell to open: December 110.00 strike calls (FYNLF)
Sell to open: December 100.00 strike puts (FYSXV)
Buy to open: December 95.00 strike puts (FYSXQ)
Limit credit: 2.00

December 115 call = -0.0159 (bought) = -0.0159
December 110 call = -0.0279 (sold) = +0.0279
December 100 put = -0.0304 (sold) = +0.0304
December 95 put = -0.0180 (bought) = -0.0180
Summary
Since we sold the middle options, then the theta is actually a positive for us. The options we bought (outside strikes) have negative deterioration against us.
December 115 call = -0.0159
December 110 call = +0.0279
December 100 put = +0.0304
December 95 put = -0.0180
The sum of -0.0159 and -0.0180 = -0.0339
The sum of +0.0279 and +0.0304 = +0.0583
Adding -0.0339 and +0.0583 = +0.0244
Summary:
This means every day you can stay in the option trade (not taking into account stock price changes) you will profit +0.0244 on the number of contracts traded from time value deterioration. If the stock moves outside of these strike prices and then returns back to them a month later, then you will have a big gain because of all that time that has deteriorated in your favor!

Iron Condor Trade details:
Buy the December Iron Condor
Buy to open: 115.00 strike calls
Sell to open: 110.00 strike calls
Sell to open: 100.00 strike puts
Buy to open: 95.00 strike puts
Limit credit = 2.00
Breakeven prices are $98.00/share & 112.00/share
Max risk = 3.00
Max reward = 2.00