How Does ‘Time Decay’ (Theta) Affect the Value of an ITM Option Compared to an OTM Option?

Time decay, measured by Theta, negatively affects the value of all options, as they lose their extrinsic value as expiration nears. However, an 'in-the-money' (ITM) option's value is primarily composed of its intrinsic value, which is not affected by Theta.

An 'out-of-the-money' (OTM) option's value is entirely extrinsic, meaning it is much more sensitive to Theta decay. Therefore, OTM options lose value faster in percentage terms than ITM options as time passes.