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Expire Worthless - Definition
Expire Worthless is when options enter expiration out of the money and expire without any remaining value.
Expire Worthless - Introduction
One of the first and perhaps most scary thing most beginners to options trading hear about options is that they eventually expire and can sometimes expire worthless, losing you all the money you put towards buying the options.
However, is it always a scary and negative thing for an option to expire worthless?
Good news is, its not always a bad thing.
Expiring worthless is one of the most common terms used in options trading. Options expire worthless whenever they go into expiration out of the money. When this happens, the options simply disappear from your trading account and cease to exist. Even though expiring worthless sounds scary to most options beginners, it isn't necessarily a bad thing. In fact, you may sometimes want options positions you hold to expire worthless.
This tutorial shall explore in depth what happens when an option expires worthless, what it means to expire worthless for call options and put options and how expiring worthless isn't necessarily a bad thing.
What Does It Mean For Options To Expire Worthless?
An options position expires worthless when it is out of the money through expiration. As such, this phenomena is also known as "expire out of the money".
Options expire on the third Friday of each month (known as "Options Expiration" day) and all options positions, whether long or short, which are out of the money during this time expire with no remaining value and simply disappears from the options account. All options positions, whether long or short, which are in the money during this time are exercised automatically (known as "Automatic Assignment") and also disappears from the options account to be replaced with a position in the underlying asset. Yes, all options disappear after expiration, the only difference is in whether they are assigned or expire worthless.
When you hold a long position in an option (meaning you bought an option) and the option expires worthless, you lose the whole amount of money used in buying that option, nothing more.
Alternatively, when you hold a short position in an option (meaning you wrote an option) and the option expires worthless, you get to keep the entire options premium gained from the sale as profit.
When Does Call Options Expire Worthless
Call options expire worthless when they enter expiration with strike price higher than the price of the underlying asset. Call options give you the right to buy the underlying asset at its strike price and the right to buy at a higher price than the actual price of the underlying asset (since you can buy the asset directly at a lower price) is worth nothing by expiration.
When Does Put Options Expire Worthless
Put options expire worthless when they enter expiration with strike price lower than the price of the underlying asset. Put options give you the right to sell the underlying asset at its strike price and the right to sell at a lower price than the actual price of the underlying asset (since you can sell the asset directly at a higher price) is worth nothing by expiration.
When Is Options Expiring Worthless an Advantage?
From the above examples it is clear that in options trading, options writers would love to have the options they write expire worthless so that they get to keep the whole premium received as profit. Until a short options position expire worthless, the premium received upon sale isn't earned as profit yet and could very well be returned to the market if the writer buys back (Buy to Close) the options to close the options position.
When Is Options Expiring Worthless a Disadvantage?
From the above examples, it should also be clear that options expiring worthless works against options buyers as the entire investment they made into buying those options would be lost. However, the good thing about buying options is that the worst that can happen is for the option to expire worthless. You cannot lose more than what you put into buying those options but can make an unlimited profit as long as the price of the underlying asset continues to move in the favor of your options (upwards for call options and downwards for put options).
What Actually Happens When An Option Expires Worthless
All options contracts expires and are delisted from the options market after expiration day. All options that are at least $0.01 in the money after expiration Friday (Third Friday of each month. For instance, an April option would expire on the third Friday of April.) are automatically assigned and all options that are out of the money after expiration Friday simply disappears from the market. Either way, the options contract would be delisted (taken off the market and cease to be traded) and struck off from the options books after expiration.
Is It True 80% Options Expire Worthless?
There has been this myth going around trying to make options trading look very risky saying that 80% of all options expire worthless in the options market. This instantly bring about a sense that 80% of options traders lose money. Now, lets assume this myth is true (before I prove it wrong shortly), it still doesn't mean 80% of options traders lose money. Remember that expiring worthless only work against options buyers? Yes, options writers actually make money and profit if options expire worthless (options writers are trading against a market maker rather than another options trader so there won't actually be a corresponding options buyer losing the trade to you!)! Won't that make options writing an 80% winning trading activity? This is also the most common marketing gimmick used by some options gurus selling options writing strategies. Furthermore, short options used as part of an options spread are meant to expire worthless in the first place! So, options expiring worthless really isn't necessarily a bad thing in options trading.
Sadly for the options writers, it isn't true that 80% of options expire worthless in the options market. According to data from the CBOE, about 80% of options are CLOSED by expiration, rather than expire worthless. This means that about 80% of options contracts are closed out before they even expire! This is totally different from what the 80% expire worthless myth suggests! Options contracts could have been closed out for profit or rolled forward to the following month. In fact, most options traders close their options positions before expiration rather than hold a position through expiration. Read our full coverage on Do 80% of Options REALLY Expire Worthless?