In my previous article, Options - It's Greek to Me and It's Greek to Me - Delta and Gamma, you learned what option Greeks are all about and the importance of delta and gamma. This article I will cover theta and rho.

Theta, or the time decay factor, is the rate at which the option premium drops as time passes. It is usually expressed a points lost per day when all other factors effect option price are constant. If an option losses 0.10 points per day, it is said to have a theta of -0.10.

A long option position (call or put) will have a negative theta whereas a short position will have a positive theta. Consider a buyer and a seller of an option and assume asset price does not change. The buyer spends $2.00 for the option (long) and the seller pockets that $2.00 (short). As time passes and the asset does not move, the value of the option decreases and the buyer (long) losses money while the seller (short) gets to keep it. Passage of time was negative for the buyer and positive for the seller.

There are always tradeoffs when trading and in option trading it is usually between underlying asset movement and time decay. If we are in a position with positive gamma in which we want the underlying to move, the position will have a negative theta where the passage of time will hurt the position. A positive gamma position will always have a negative theta and vice versa.  This is why a long straddle or strangle (positive gamma) should be entered with a long time to expiration (low negative theta). Short straddles or strangles should be entered close to expiration when positive position theta is high.

We will now turn to rho and interest rates. Of all the Greeks, rho is probably the least important. Rho measures the change in option premium with a 1% change in interest rates.

Call option premium increases as interest rates go up because it is more favorable to buy a call when rates are high than to buy stock. The purchase of stock will have a high carrying cost. Put option premium decreases as interest rates go up since shorting stock and earning interest on the funds is more favorable than buying puts.

Rho increases as you go from OTM options to ITM options since option premium increases as an option goes ITM. This is because your cash outlay does have a carrying cost, i.e. the interest you could be earning on that money.


In summary, if your position theta is positive, the passage of time will increase the value of you position. If the position theta is negative the passage of time will decrease the value of the position. If your position rho is positive, you want interest rates to increase resulting in increased position value. If position rho is negative, you want interest rates to decrease resulting in increased position value.