Options expiration is crucial in preventing traders from holding their positions indefinitely, ensuring that a specific timeframe governs the validity of their trades.
Efficiency and balance are essential in options trading to ensure a fair playing field. Options expiration serves as a mechanism to uphold this equilibrium, simultaneously influencing the interplay between supply and demand dynamics.
This article will tell you everything you need about options expiration dates. The Options Clearing Corporations offers a helpful document that discusses the characteristics and risks of options, which can be found on their website.
What Are Options Expiration Dates?
Options expiration dates refer to the predetermined dates on which an option contract ceases to be valid. This date plays an important role in option trading strategy. They define the timeframe within which investors must exercise their rights or take appropriate action on their options positions.
Depending on the types of options, there can be monthly, quarterly, or even weekly options. To illustrate the concept of options expiration, let’s consider an example:
Suppose an investor holds a call option on a specific stock with an expiration date of the third Friday of the month. If the stock position rises above the strike price before or on the expiration date, the investor can exercise the option and buy the underlying shares at the predetermined price. However, if the stock price remains below the strike price, the option will expire worthless, and the investor loses the premium paid for the option.
Basics of Options Expiration
Options expiration is an essential part of derivatives trading. Here are some other factors that an investor should know before trading options:
Call Options
A call option gives the holder the right, but not the obligation, to buy the underlying asset at a specified price (the strike price) within a predetermined time frame. A covered call is an example of a specific strategy involving a call option. Call options provide investors with the opportunity to profit from potential price increases in the underlying asset, but there are risks such as losing the entire premium paid for the option.
For example, let’s say an investor purchases a call option on a firm’s stock with a strike price of $50 and an expiration date of one month. If the stock price rises above $50 before or on the expiration date, the investor can exercise the option and buy the stock at the strike price. This allows the investor to benefit from the price appreciation. However, if the stock price does not rise above $50 before or on the expiration date, the call option will expire worthless. This means that the investor will lose the entire premium paid for the option and will not be able to exercise it to buy the stock at the strike price.
Put Options
A put option gives the holder the right, but not the obligation, to sell the underlying asset at a specified price within a predetermined time frame. Put options provide investors with the opportunity to profit from potential price declines in the underlying asset, but there are risks such as losing the entire premium paid for the option.
Suppose an investor purchases a put option on a firm’s stock with a strike price of $50 and an expiration date of one month. If the stock price falls below $50 before or on the expiration date, the investor can exercise the put option and sell the stock at the strike price. This allows the investor to benefit from the price depreciation. However, if the stock price does not fall below $50 before or on the expiration date, the put option will expire worthless. This means that the investor will lose the entire premium paid for the option and will not be able to exercise it to sell the stock at the strike price.
Expiration and Option Value
Options expiration plays an important role in determining the value of options contracts. The value of an option is composed of two components: intrinsic value and extrinsic value (also known as time value).
Intrinsic Value
The intrinsic value of an option is the difference between the current price of the underlying asset and the strike price. It represents the immediate profit an investor would gain if they were to exercise the option at that moment. Other factors may affect the value of an option, such as its extrinsic value. Extrinsic value, also known as time value, is the portion of the option’s price that exceeds its intrinsic value. It is determined by factors other than the price of the underlying security, such as time decay and implied volatility. These factors can cause the value of an option to decrease, even if the intrinsic value remains the same.
For instance, if a call option has a strike price of $100 and the underlying stock position is trading at $120, the option has an intrinsic value of $20 ($120 – $100). This means the option holder could buy the stock at a discounted price and immediately sell it at a higher market price. If a call option has a strike price of $100 and the underlying stock position is trading at $100 or below, the option has zero intrinsic value. This means that the option holder would not be able to buy the stock at a discounted price and immediately sell it at a higher market price.
Alternatively, if a put option has a strike price of $80 and the underlying stock is trading at $70, the option has an intrinsic value of $10 ($80 – $70). The option holder could sell the stock at a higher strike price even if the market value is lower. If a put option has a strike price of $80 and the underlying stock is trading at $80 or above, the option has zero intrinsic value. This means that the option holder would not be able to sell the stock at a higher strike price even if the market value is lower.
Extrinsic Value (Time Value)
Extrinsic value, also referred to as time value, represents the portion of an option’s premium that is not attributed to its intrinsic value. It reflects the potential for the underlying asset’s price to move positively before the expiration date.
The factors influencing time value include the remaining time until expiration, the expected price volatility of the underlying asset, interest rates, and market demand on the options market.
As expiration approaches, the time value of an option decreases. This is known as ‘time decay’. It occurs because there is less time for the underlying asset’s price to make significant moves in favor of the option holder. Time decay is usually more pronounced for options that are further out of the money.
What Are Your Choices Before Expiration?
Before an option contract reaches its expiration date, investors have several choices to consider based on their investment objectives and market conditions. Here are some of the choices available:
Exercising Options
You can choose to exercise your options before expiration if it aligns with your trading strategy. By exercising a call option, you have the opportunity to buy the underlying asset at the strike price. This exercise of a put option allows you to be an option seller at the strike price. Exercising an option can be advantageous when the option has intrinsic value and the investor believes the underlying asset’s price will move further in their favor after exercise. However, it is important to note that exercising an option also requires sufficient capital and may result in transaction costs.
Selling Options
Instead of exercising options, investors can choose to sell their options contracts to other market participants. By selling options, investors can capitalize on any remaining time value and profit from the sale without exercising the options.
Selling options can be effective when the options have time value remaining but the investor does not expect to exercise them. This approach allows investors to benefit from the premium received by selling the options.
However, selling options can also be risky when the market moves adversely and there isn’t an exit strategy or hedge in place. Some of the risks associated with selling options include time decay risk, volatility risk, dividend risk, and pin risk.
What Happens After Expiration?
Once options contracts reach their expiration dates, several outcomes are possible. Let’s explore what happens after expiration:
Exercised In-the-Money Options
If an option is in-the-money (the underlying asset’s price favors the holder), it will likely be automatically exercised by the options clearinghouse. The investor will either buy or sell the underlying asset at the predetermined strike price.
For example, if an investor holds a call option with a strike price of $50 and the underlying stock price is $60 on the expiration date, the option will likely be automatically exercised. The investor will buy the stock at $50, which is the share price.
Similarly, if an investor holds a put option with a strike price of $50 and the underlying stock price is $40 on the expiration date, the option will likely be automatically exercised. The investor will sell the stock at $50 per share.
Unexercised or Out-of-the-Money Options
Out-of-the-money options (where the underlying asset’s price does not favor the holder) usually expire worthless. Investors who hold these options will risk losing the premium paid for them but will not be obligated to buy or sell the underlying asset.
For instance, if an investor holds a call option with a strike price of $50 and the underlying stock price is $40 on the expiration date, the option will likely expire worthless. The investor will not exercise the option, and the premium paid for the option will be lost.
Similarly, if an investor holds a put option with a strike price of $50 and the underlying stock price is $60 on the expiration date, the option will likely expire worthless. The investor will not exercise the option, and the premium paid for the option will be lost.
Options Expiration Checklist: Manage and Monitor Expiration Risk
To help effectively manage options expiration risks, here is a checklist:
Understand the Basics of Options: Gain a solid understanding of options terminology, including strike price, expiration date, and the distinction between call and put options.
Determine the Expiration Date and Time: Take note of the specific expiration date and time for your options contracts. This information is crucial for planning your actions and avoiding unexpected outcomes.
Check the Options Expiration Calendar: You can consult an options expiration calendar which is found on a financial website or trading platform. This calendar provides a comprehensive overview of upcoming expiration dates, allowing you to stay informed and plan accordingly.
Review Your Option Position: Regularly review and assess your options positions, considering factors such as the current price of the underlying asset, the time value remaining in the options, and your overall investment strategy.
Understand Option Settlement Methods: Familiarize yourself with the settlement methods for options contracts, as they can vary depending on the type of option and the underlying asset. Common settlement methods include physical delivery (for stocks) and cash settlement (for indices and some commodities).
Consider Liquidity: Evaluate the liquidity of the options you hold or plan to trade. Liquidity refers to the ease with which you can buy or sell options contracts without significantly impacting their market price.
Review Trading Strategies: Continuously review and refine your options trading strategy to align them with your investment advice, goals and market conditions. Consider adjusting your positions or using techniques to manage and improve risk tolerance.
Seek Professional Advice and Educate Yourself: Consult a qualified financial advisor or options trading expert to gain valuable insights and guidance. Additionally, use educational resources, books, and online courses to enhance your knowledge and understanding of options trading strategies.
Conclusion
Understanding options expiration dates and managing expiration risks is important to making informed investment decisions for options traders. While Public.com does not yet offer options in the platform, it offers access to other investment assets, including stocks, ETFs, and more. You can stay informed and continuously educate yourself.
Join Public.com today and experience the power of robust tools to unlock your full investing potential.
FAQs
Can I hold options until expiration?
Yes, as an options holder, you have the right to hold your options contracts until their expiration date. This can be a valid strategy, depending on your investment objectives and market conditions.
What happens to options on expiration day?
On options expiration day, options contracts can be exercised, sold, or left to expire, depending on the investor’s decisions and the options’ profitability. Options that are in-the-money are likely to be automatically exercised, while options that are out-of-the-money typically expire worthless. You can easily deal with options at expiration by regularly checking the calendar.
Do You Lose Money if Options Expire?
If options expire out-of-the-money, investors may lose some money at expiration. This is the premium they paid for the options contracts. However, if options expire in-the-money, investors can profit from their options positions. If options expire out-of-the-money, the seller of the option will keep the premium they received when they sold the option and will not have to pay anything at expiration. However, if options expire in-the-money, the seller of the option may have to pay the difference between the strike price and the market price of the underlying asset, which could result in a loss.
What Time Do Options Expire?
Options typically expire at the market close on their respective expiration dates. However, it is crucial to check the specific market rules and trading hours, as they may vary depending on the exchange and the type of asset.
How long is an options expiration cycle?
Options expiration cycles can vary based on the type of options. Monthly options generally have an expiration cycle of one month, while quarterly options expire every three months. Additionally, there are weekly options that provide shorter-term trading options with expirations within a week.
