Do In-The-Money Options Have Time Decay?

You’ve made a smart move, buying in-the-money options. But what if I told you that even your in-the-money position is losing value with each passing day? You might think that being in-the-money (ITM) means you're safe from the dreaded “time decay,” but this couldn’t be further from the truth.

Let's break it down right from the start. Time decay, also known as theta, is one of the most important aspects of options trading, but it often gets overlooked. Why? Because traders tend to focus on the price movement of the underlying asset and forget how time affects their position. In-the-money options also experience time decay, though not as rapidly as out-of-the-money (OTM) options.

The key to understanding time decay in ITM options is knowing how much intrinsic value your option has. The deeper an option is in the money, the more its price is made up of intrinsic value rather than time value. However, no matter how deep in-the-money your option is, part of its value is still based on time, and that part decreases with each day.

The Misconception of Safety

It’s easy to fall into the trap of thinking that as long as your option is in-the-money, you're safe from significant losses. While in-the-money options tend to hold value better than OTM options, the fact is that time decay will always be a factor.

Here’s an example: If you have a call option with a strike price of $100, and the stock is trading at $110, your option is $10 in-the-money. That $10 represents the intrinsic value. But the option might still be trading at $13, meaning you’ve got $3 of time value. As time goes by, that $3 starts to shrink until it becomes zero by expiration. This means your option’s value is steadily declining, even if the stock price remains constant.

Time decay accelerates as the option nears its expiration date. This can catch many traders by surprise, especially if they're new to options trading. The problem becomes particularly severe in the final month before expiration, when the majority of the time decay happens.

Understanding the Greeks

To truly grasp how time decay affects ITM options, you need to understand the Greeks, particularly theta. Theta measures how much an option’s price will decrease with the passage of time, all else being equal. For example, if your option has a theta of -0.05, you’ll lose 5 cents from the option’s price every day due to time decay.

But here’s where it gets interesting: Theta isn’t constant. As your option approaches expiration, theta accelerates. So even though you might have started with a very small time decay, it increases as the expiration date looms closer.

Below is a table showing how time decay can affect options over time:

Days to Expiration	Option Price	Intrinsic Value	Time Value	Theta
90	$13	$10	$3	-0.05
60	$12	$10	$2	-0.08
30	$11	$10	$1	-0.12
10	$10.50	$10	$0.50	-0.18
1	$10.10	$10	$0.10	-0.30

As you can see, time value erodes faster the closer you get to expiration. For this reason, even ITM options can lose value rapidly in the final days before expiration. The deeper your option is ITM, the more its price will resemble the intrinsic value as time passes. But don’t be fooled — even deep ITM options are vulnerable to time decay.

Why Traders Ignore Time Decay

Many traders fail to properly account for time decay when trading ITM options because they're overly focused on the direction of the stock price. They assume that as long as the stock moves in their favor, they’ll make money. But what if the stock stays flat or moves too slowly? In that case, time decay can easily eat up any gains.

For example, imagine you bought an ITM call option expecting the stock to rise. The stock does increase, but only by a small amount. By the time the stock moves, the time decay might have already eaten away much of the profit, leaving you with a break-even or even a loss.

Experienced traders know that options trading is not just about being correct about the direction of the stock — it’s also about being right within a specific timeframe. This is why understanding time decay is crucial.

Hedging Against Time Decay

There are strategies you can use to hedge against time decay. One popular approach is rolling. This involves closing your current option position and opening a new one with a longer expiration date. Rolling helps reduce the impact of time decay because options with more time until expiration decay at a slower rate.

Alternatively, some traders use spreads to limit time decay. A common strategy is the bull call spread, where you buy an ITM option and sell a higher strike price OTM option. This reduces your net cost and limits time decay exposure.

Here’s an example of how a bull call spread works:

Buy Call (ITM)	Sell Call (OTM)	Net Cost	Time Decay Impact
Strike Price $100	Strike Price $110	$5	Lower than ITM alone

By using a spread, you’ve reduced the overall cost of your trade, which minimizes the impact of time decay. The idea is that as long as the stock rises before both options expire, you can still make a profit, but with less risk from time decay.

When Time Decay Works in Your Favor

Not all traders fear time decay. In fact, many advanced strategies take advantage of it. If you're selling options, for example, time decay can work in your favor. When you sell an option, you're betting that it will either expire worthless or decrease in value, so you can buy it back at a lower price. Time decay accelerates this process, allowing you to potentially profit without a significant move in the underlying stock.

Selling ITM options, however, can be risky because of their intrinsic value. But if you sell an option that has just a small amount of intrinsic value and a large time value, you could benefit from time decay while managing your risk.

Conclusion

Time decay affects all options, even those that are in-the-money. While ITM options have more intrinsic value than OTM options, they are still subject to the inevitable erosion of time value. As a trader, it's important to account for this factor when choosing your strategy. Whether you're holding an ITM option or selling options, understanding how time decay works can make or break your trade.

In summary: yes, in-the-money options do have time decay. It might not be as aggressive as with out-of-the-money options, but ignoring it can cost you dearly.