In Part 3 of our theta investigation, we are going to explore the impact of weekends and holidays and then talk about portfolio theta. If you missed our previous posts you can find Part 1 here and Part 2 here.

Let’s recap the two critical characteristics of theta’s behavior that we’ve identified so far:

One: Theta measures the rate of time decay per day.

Two: Theta is highest for short-term options and lowest for long-term ones.

Three: Theta is highest for ATM options and shrinks as you move further ITM or OTM.

Weekends and Holidays

Here’s a common question I hear. Perhaps it’s one you’ve pondered yourself.

“Does theta measure the rate of decay per calendar day or trading day?”

Remember, there are 365 calendar days in the year but only about 252 trading days due to market closures on the weekend and holidays. If theta is per calendar day, then you should sell options on Friday instead of Monday to pick up two free days of theta. That means you’re better off entering trades like covered calls, naked puts, and iron condors on a Friday. Said another way, you should buy options on Monday instead of Friday to dodge two days of time decay. So, long calls and puts are best entered on a Monday because you sidestep the guaranteed loss of owning them over the weekend.

Such would be true if theta were per calendar day, and the market wasn’t efficient. But the market is efficient! Weekend and holiday decay is taken out ahead of time. There is no edge to selling options on a Friday or buying on Monday.

If there were, in an efficient market everyone would sell options on Friday (thus driving down their prices) and buy options on Monday (thus driving up their prices) and the weekend decay would disappear!

What you’ll discover is that the market essentially prices in seven calendar days of decay over five trading days. By the closing bell on Friday, options should already be priced as if it’s Monday morning.

The same phenomenon goes for holidays.

Portfolio Theta

Just as you can calculate theta for an individual position, you can calculate if for an entire portfolio. It is an additive process. Suppose you have the following trades in your account:

AAPL Theta +10

MSFT Theta +5

AMD Theta +20

RUT Theta -10

To calculate the portfolio theta, you would sum up the theta of each position like so: 10+5+20-10 = 25. Your portfolio theta is +25. Here’s what that means. All else being equal, you should be making $25 a day due to time decay. In theory, you should be making $25 a day.

And by “all else being equal,” we mean that every other variable that impacts option pricing is held constant. The stock price isn’t moving. Nor is implied volatility.

Unfortunately, in the real world, all else is never equal. That is why a portfolio theta of +25 will never deliver $25 of profit into your pocket every single day. Some days you’ll lose money, even with a positive theta portfolio, due to adverse movement from other variables. Other days you’ll make much more than $25 because of favorable movement from other variables.

Here are three things we can say:

One: If your portfolio theta is positive, time is helping you. Your portfolio has the potential to generate cash flow over time.

Two: The higher your portfolio theta, the more significant the impact of time decay to your bottom line. A trader toting a +100 portfolio theta has the potential to capture more gains per day than one holding a +20 portfolio theta.

Three: The higher your portfolio theta relative to the other greeks, the more time will be the driver of your performance.

The first two points are hopefully obvious. The third one needs an example. Suppose we have two portfolios.

Portfolio A: Delta +500, Theta +100, Vega +300

Portfolio B: Delta +25, Theta +100, Vega +30

Both accounts have a theta of +100. But Portfolio B’s return will be driven more by time decay because theta is LARGE relative to the other greeks.

Here’s a snapshot of where you can find your portfolio’s theta in ThinkorSwim. It’s the blue box.

Boosting Portfolio Theta

If you want to increase your portfolio theta, then sell more options. It’s that simple. Whether you sell calls or puts or some type of spread depends on your directional bias and what makes the most sense given your existing portfolio.

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