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Empirical patterns of time value decay in options

Empirical patterns of time value decay in options The purpose of this paper is to conduct an empirical analysis of the pattern of time value decay in listed equity options, considering both call and put options and different moneyness and maturity levels.Design/methodology/approachThe research design is empirical, with great attention paid to creating a standardized measure of time value that can be both tracked over time for an individual option contract and meaningfully compared across two or more different option contracts.FindingsThe author finds that moneyness classification at the beginning of the holding period is the key determinant of the pattern of subsequent time decay. The type of option, call or put, and the maturity of the contract have surprisingly little relevance to the pattern of time decay “out-the-money contracts having similar patterns on average, regardless of whether they are calls or puts, 30-day or 60-day contracts.” More detailed analysis reveals that In-the-money and out-the-money contracts have slow time decay for most of the contract life, with a significant percentage of the time decay concentrated on the final day of the option. At-the-money contracts experience strong decay early in the life of the option.Research limitations/implicationsThe study is limited by not having intra-day data included to analyze more frequent price movements.Practical implicationsThe results reported in the paper provide insight into issues of active management facing options traders, specifically choices such as the initial maturity of the option contract and rollover frequency.Originality/valueVery few studies examine the important issue of how option time value behaves. Time value is the subjective part of the option contract value, and therefore very difficult to predict and understand. This paper provides insight into typical empirical patterns of time value behavior. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png China Finance Review International Emerald Publishing

Empirical patterns of time value decay in options

McKeon, Ryan
China Finance Review International , Volume 7 (4): 21 – Oct 11, 2017
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Publisher
Emerald Publishing
Copyright
© Emerald Publishing Limited
ISSN
2044-1398
DOI
10.1108/cfri-09-2016-0108
Publisher site
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Abstract

The purpose of this paper is to conduct an empirical analysis of the pattern of time value decay in listed equity options, considering both call and put options and different moneyness and maturity levels.Design/methodology/approachThe research design is empirical, with great attention paid to creating a standardized measure of time value that can be both tracked over time for an individual option contract and meaningfully compared across two or more different option contracts.FindingsThe author finds that moneyness classification at the beginning of the holding period is the key determinant of the pattern of subsequent time decay. The type of option, call or put, and the maturity of the contract have surprisingly little relevance to the pattern of time decay “out-the-money contracts having similar patterns on average, regardless of whether they are calls or puts, 30-day or 60-day contracts.” More detailed analysis reveals that In-the-money and out-the-money contracts have slow time decay for most of the contract life, with a significant percentage of the time decay concentrated on the final day of the option. At-the-money contracts experience strong decay early in the life of the option.Research limitations/implicationsThe study is limited by not having intra-day data included to analyze more frequent price movements.Practical implicationsThe results reported in the paper provide insight into issues of active management facing options traders, specifically choices such as the initial maturity of the option contract and rollover frequency.Originality/valueVery few studies examine the important issue of how option time value behaves. Time value is the subjective part of the option contract value, and therefore very difficult to predict and understand. This paper provides insight into typical empirical patterns of time value behavior.

Journal

China Finance Review International – Emerald Publishing

Published: Oct 11, 2017

Keywords: Options; Time decay; Time value; G11; G13

References

  • The pricing of options and corporate liabilities
    Black, F.; Scholes, M.
  • Why are put options so expensive?
    Bondarenko, O.
  • Empirical time decay properties of call options prices
    Brozik, D.
  • Expected option returns
    Coval, J.D.; Shumway, T.
  • Returns from trading call options
    McKeon, R.
  • Stock option returns: a puzzle
    Ni, S.
  • Expected time value decay of options: implications for put-rolling strategies
    Tannous, G.; Lee-Sing, C.
  • Option returns versus asset-pricing theory: evidence from the European option market
    Wilkens, S.