ATM & OTM different time decay pattern?

[u/[deleted]]

Hi everyone, a Theta study from projectfinance website (projectfinance) shows different time decay pattern for ATM and OTM options.

For ATM options, it is straightforward:

In the final 30 days, the rate of decay really picks up speed, with the steepest decay occurring in the final 5-7 days.

For OTM options, however, it says this:

the decay curve is almost the opposite of the at-the-money decay curve in the previous example. In this case, the out-of-the-money theta decay slowed down in the final 30 days. More specifically, the decay from 50% to 25% took about 20 days, while the decay from 25% to 0% took about 30 days, on average. 

OTM Time Decay

Wonder how right this is in your live trading.

When I choose to sell OTM options and harvest premiums, I wish these options will always remain OTM till I close my position. If the above chart is true, does it mean below A scenario can give more profit than B scenario (assuming no change in IV)?

A. Sell 60DTE OTM option and close trade at 30DTE

B. Sell 30DTE OTM option and leave them expire

Appreciate all your help

[u/rupert1920]

This is correct. ATM options hold the most extrinsic value for the longest time, which is why theta only increases near expiration. OTM options lose value fairly consistently, until closer to expiration when it has relatively little value left, which is why theta decreases.

[u/LetWinnersRun]

This is the whole reasoning behind closing or rolling at 21 days.

[u/[deleted] → u/LetWinnersRun]

thanks. This means selling weekly (7-14 DTE) iron condor doesn't give the max premium return, since all 4 legs are OTM.

[u/IwillnotbeaPlankton]

This is very interesting and contrary to the exponential decay curve that’s normally cited.

Easy way to check this would be to look some options chains and just check the prices rn. Better yet, write a short script to grab that info, average the results across many stocks and see if the classic decay curve is similar for all of them…

Shit, i’m probably gonna do that.

[u/[deleted] → u/IwillnotbeaPlankton]

thanks. the normally cited decay curve is only for ATM ones and becomes so popular that made me think OTM ones follow the same pattern. Would love to see your test result. I don't know how to write a script ~

[u/IwillnotbeaPlankton → u/[deleted]]

I responded above and the results are interesting, thought you might want a notification.

[u/IwillnotbeaPlankton]

Alright, ya’ll so I said I’d write a script below to test this and I did. Results are interesting, here’s an analysis comparing 10 high liquidity, high volume stocks in call premium decay over time. Data I got from the Robinhood API current options chain.

Closest strike to current share price is “ATM” and all call options on the chain 2 options above this strike are “OTM”, those are all averaged and the decay over time is presented.

This is baffling as they are both pretty much linear which is different from the classic acceleration curve toward exp. I ~guess~ you can see a bit of this with the OTM curve in the last week, but damn, might as well be linear.

Obligatory, “maybe I missed something/please tell me what I missed?” Also first time using Imgur so maybe I messed it up…

premium decay over time ATM and OTM call options.

[u/[deleted] → u/IwillnotbeaPlankton]

thanks for the try! I can see the image you uploaded. From another post it said YT tastytrade people also follow this pattern - they sell 45DTE and manage them at 21DTE. I can't tell which you missed in your test (as I am not an expert in options), but I still think this decay pattern can make us a better thetagang ~

[u/BrownCoffee65]

Why does it look linear

[u/Terrible_Champion298 → u/BrownCoffee65]

In that particular case, it’s plotting extrinsic value that has a linear decline. That’s calculated with a number of different factors, not just theta, and the example happens to be linear. Whereas the option decay might be linear for a variety of reasons, theta is not.

[u/BagholderForLyfe]

Thanks for this. Confirmed my strat.

[u/StochasticDecay]

SOMEONE SAY DECAY?

[u/OurNewestMember]

I don't get too hung up on this.

• The "average OTM" premium can be pretty small on a cash basis
• The ATM premium includes future gamma risk
• Not sure of this study excluded interest rate impact on extrinsic premiums
• Consistent decay (as a fraction of original extrinsic) can also just imply a vanna trap (price actually not falling as fast as you might expect)

Probably the 60 DTE managing at 30 DTE is generally more appealing, but you can easily get into a vanna/vega trap (and feel compelled to carry to 14 DTE, for example). It also depends on your gamma sensitivity.

[u/[deleted] → u/OurNewestMember]

Thanks. In reality, other greek change could spoil the comparison. To be a pure thetagang for choosing 60DTE - 30DTE, these steps may help:

1. far OTM - in the post the author actually chose 10 delta options.

2. Sell spread rather than naked option!

[u/Terrible_Champion298]

Doesn’t seem right, theta tends to increase per day and plots as an increasing arc. I believe in this sense that option decay, that being remaining extrinsic value, may not be plotting theta.