Empirical Patterns of Time Value Decay in Options

Abstract

I conduct and empirical analysis of the pattern of time value decay in listed equity options, considering both call and put options and various degrees of moneyness for both classes of options. I find that empirical patterns differ from model or theory based predictions in important ways. While model-based simulations commonly predict slow decay in time value with rapidly accelerating decay as the option approaches expiry, the empirical results show that time value decay is often very rapid early in the holding period of an option. This result holds regardless of holding period duration (30, 60 and 90 days are considered) and moneyness. Further analysis reveals the differences between empirical results and model-based predictions are largely due to changes in stock price during the holding period, with deviations in the market price of the option from model-based prices being a minor factor. The only options to exhibit rapidly accelerating time value decay are out-the-money calls or puts purchased in low-volatility environments. I discuss the implications of these results for the management of option positions.