The amount of the change in an option price with respect to the decrease in time to expiration. The option value declines with the passage of time. Option time value is the portion (of option value) which has a positive relationship with time. The longer the time to maturity, the higher the time value. As options approach expiration dates, they lose a part of their time value (and therefore, a part of their total value), but what makes matters worse is an out-of-the-money option approaching expiration. In contrast, an in-the-money option has the potential to generate a payoff even when its time value is declining, because any likely, favorable movement in the underlying asset price would sufficiently compensate the option holder for time decay.

If the option is out of the money, time decay starts to increasingly build up in the last two months and one month to expiration. However, deep in the money options suffer a faster time decay, as they will be deemed expensive with regard to other options. Holders of a deep in the money option would prefer to realize its intrinsic value at the expense of sacrificing its time value, because the former is substantially larger than the latter.

Time decay is also known as “theta” or “time-value decay” or “rent“.