Option Premium & Time Decay Explained – Nifty Options Guide | CapitalKeeper
By CapitalKeeper | Beginner’s Guide | Indian Equities | Episode 6 Day-2
Discover how option premium and time decay (Theta) impact your Nifty & Bank Nifty option trades. Learn pricing factors and practical trading tips.
Week 6 – Day 2: Understanding Option Premium & Time Decay
Objective:
To understand how option premiums are calculated, factors affecting them, and how time decay (Theta) impacts both buyers and sellers of options.
1. What is Option Premium?
- The option premium is the price paid by the buyer to the seller for acquiring the rights of an option.
- Premium = Intrinsic Value + Extrinsic Value
Intrinsic Value
- Value derived from how much the option is ITM (In-the-money).
- Example: If Nifty is 25,000 and you hold 24,800 CE, intrinsic value = 200.
Extrinsic Value
- Additional price due to time left till expiry and implied volatility.
2. Factors Affecting Option Premium (Option Greeks)
- Delta – How sensitive option price is to the underlying movement.
- Example: Delta 0.5 → option price moves 5 points if underlying moves 10 points.
- Theta (Time Decay) – Rate at which option premium decreases daily as expiry nears.
- Fastest in the last 3-5 days before expiry.
- Vega (Volatility Impact) – Measures how premium changes with implied volatility.
- High volatility = high premium (risk premium).
- Gamma – Measures the rate of change of Delta (important near expiry).
3. Time Decay (Theta) Explained
- Definition: Gradual erosion of option value with time, even if price stays same.
- Key Point: Time works against buyers and for sellers.
- Example:
- Nifty 25,000 CE = 120 on Monday → falls to 90 by Wednesday without price change.
4. Real-Life Example with Nifty
- Scenario: Nifty at 25,000, 25,200 CE at ₹80 (weekly expiry).
- If Nifty stays flat:
- By mid-week → Premium may drop to ₹45.
- By expiry → Premium may drop to ₹0.
Learning: Buyers must enter with momentum; sellers can profit from sideways markets.
5. How to Use This in Trading
- For Buyers:
- Avoid buying far OTM options with low time value close to expiry.
- Prefer trades during momentum phases.
- For Sellers:
- Exploit Theta decay with strategies like covered calls or credit spreads.
- Ensure strict stop loss for risk control.
Key Takeaway
Time decay is predictable — use it to plan entry/exit timing. Always combine premium analysis + technical charts for better accuracy.
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