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Options Expiration: Summary
Options Expiration Day - Definition
Options Expiration Day is the when options contracts expiring on that day becomes void and beyond which day will cease to exist.
Options Expiration - Introduction
Options Expiration is the day when options expire. Expiring means that the options contract will cease to exist after that. Options expiration days are extremely important for options traders as options with different moneyness state could expire with very different consequences to the state of your trading account. Options expiration is also extremely important for most complex options strategies and could make the difference between profit or loss.
This tutorial shall explore in detail what expiration means in options trading, its effects on options of different moneyness states and what exactly happens during options expiration.
What Is Options Expiration In The First Place?
Options are derivative trading instruments with a finite life. All options contracts expires some day, unlike assets with perpetual life like stocks.
Options expiration is when the life of an options contract runs out and is to be resolved according to the terms of the contract. This resolution is known as a "Settlement". For instance, AAPL's Jan200Call options are call options that expire on options expiration day of January. This means that you cannot expect to hold on to this options contract beyond January. Whatever profit or loss you accumulate with this options contract would be resolved (realised) on options expiration day. This is why choosing a suitable expiration month for your specific trade is so important in options trading.
It is exactly because all options eventually expire which opens up the infinite trading possibilities of options trading. Yes, options expiration isn't all bad as many versatile options strategies depend on options expiring in order to produce a profit. Yes, there may even be times in options trading when you actually want an options contract to expire as soon as possible.
When Does Options Expire?
All options expire on a pre-determined day of the expiration month. In the US market, plain vanilla stock options (regular) expire on the third Saturday of each month with the final trading day as the third Friday of the month. For instance, the Jan200Call of AAPL mentioned above would expire on the third Saturday of January. You can still sell the expiring options on the third Friday of January itself as the options will cease to exist only after Saturday.
There are options, such as quarterlies, that do not expire on the third Saturday of the expiration month. In fact, different bourses or countries may also have different regulations but in general, all options expiration days are predetermined and fixed and you should find out the exact expiration day of your options prior to buying them. You could check the exact dates for US market options expiration for the entire year at the CBOE Expiration Calendar.
What Happens During Options Expiration?
Options can still be traded on expiration day itself and there will always be market makers willing to pick them up as long as they are liquid enough (in high demand).
After expiration, options that are in the money (ITM) would be automatically exercised (Assigned) and options that are out of the money (OTM) will expire worthless and cease to exist with no obligations from both the holder or writer. This is the same no matter if the options are American style options or European style options.
If you hold an in the money call option (or short put option) through expiration, you would end up with the amount of stocks covered by the call options and the corresponding amount of cash would be deducted from your account to pay for those stocks at the strike price of the call options.
If you hold an in the money put option (or short call option) through expiration, your stocks would be sold at the strike price of the put options. If you do not also own the underlying stock, you would end up with a short position on the stock at the strike price of the put options.
If you are holding an out of the money call option or put option (both long or short) through expiration, those options will simply expire worthless and disappear from your account with no further obligations. Yes, this is the limited loss protection that options trading grants. If you buy options, you would lose no more than the money you put into buying them.
ITM long call or short put = stocks in your account after options expiration
ITM long put or short call = short stock position in your account after options expiration
OTM Options (long or short, call or put) = Expire Worthless
What happens if you hold an in the money call options or short put options through expiration and do not have sufficient money to buy the stocks? In that case, your broker will resolve the position by automatically selling the stocks at the market price and posting the net profit or loss in your options trading account.
What happens during options expiration of cash settled options? The above procedure applies only to physically settled options. In options trading, Cash settled options would also be automatically exercised if they are in the money during expiration and expire worthless if they are out of the money. However, when cash settled options expire in the money, only the net profit or loss would be posted to your trading account in cash. There will not be any exchange of physical products or assets (such as stocks).
Options Expiration Value Formula
The value of an option at expiration can be calculated using a simple formula:
Expiration Value For Call Options = Stock Price - Strike Price
Expiration Value For Put Options = Strike Price - Stock Price
Negative values represents zero value and that the option is out of the money and would expire worthless.
Actions You Can Take on Options Expiration Day
There are four actions you can choose to take for existing positions on options expiration day and they are; Close Out, Exercise, Roll Forward or Let Expire.
You could choose to close out your options position on expiration day in order to end the position. This is useful when your options are profitable and in the money. All in the money options would be liable for assignment upon expiration, as such, you should choose to close out your existing in the money options positions if you do not intend to take position in the underlying stock itself. Closing out the position means to Sell To Close existing long positions or Buy To Close existing short options positions.
All in the money options will be automatically exercised upon expiration, as such, there isn't a real need for you to manually exercise your position but you could still choose to do it.
If you wish to stay invested in the price movement of the underlying asset but your current options contracts are expiring, you could choose to roll forward your positions. This means closing out your current options contracts and then simultaneously open the same number of contracts in a further expiration month. Read more about Roll Forward.
If your options contracts are way out of the money and has no more extrinsic value left to salvage by expiration, you could simply do nothing and let the options contracts expire out of the money. These contracts will simply disappear from your account after expiration and you will no longer hold a position in those contracts.
Advantages of Options Expiration
Options expiration is a constraint for holders of long options positions but is the favorite day for writers of short options positions. Options expiration is the day where all the extrinsic value in an option would decay away, transforming totally into profit in the accounts of options writers.
If you wrote an option for $1.50 and that option expires out of the money on options expiration day, you would make that $1.50 in profit in full.
In fact, many complex options trading strategies such as the short straddle and short strangle depends on options expiring out of the money during options expiration in order to achieve their maximum profit potential.
Disadvantages of Options Expiration
Options expiration is obviously to the disadvantage of options traders who are long options positions or in a directional options trading strategy that requires the underlying stock move in a certain way before expiration. Generally, options writers would write options with as short an expiration as possible while options buyers would buy options with as long an expiration as possible.
Questions on Options Expiration
:: Will My Call Options Remain Till Expiration?
:: "Do Near Term or Long Term Options Move More?"