More on Derivatives
Options expiration or the options expiry date is a very crucial parameter while you decide to enter into a derivatives contract. Of course, you need to look at the strike price, premium amount, market trend, however, the options expiration is something that decides the strike price and the premium amount as well.
Let’s figure out how and why options expiry date carries so much attention amongst traders whilst they decide to go ahead with the contract.
Options Expiration Explained
As you know that every derivative contract has an expiry date on or before that date contract expires. Derivatives contract, which is based on underlying securities like equity, commodities or currency expires on a fixed date. Here, the point to understand is that the expiry date is for the contract (for instance Options Expiry) and not for the underlying securities.
Generally, two terms are used, one is ‘expiry’ and other is ‘Expiration’, but must be clear that these both terms are same and both means ‘date on which a contract ends’.
Also Read: How Options Work?
Options Expiration Definition
Options Expiry generally refers to the last date of an option contract on which option holders can exercise their right according to the terms OR it can be seen as the last date till which an option is valid.
In Indian stock exchanges, Option contract expires on last working Thursday of each month. While in U.S expiration of the option contract is on the 3rd Friday of each month.
Options Expiration Cycle
For most of the stock options – quarterly, monthly and weekly expiry cycles are available. When options trading started for the first time, it was decided that there would be a total of four different expiration months available for the options to trade.
But, after the introduction of long-term equity anticipation securities (LEAPS*), options were started to be traded in more than four expiry months.
*A LEAPS can expire up to 3 years from the current expiration months.
Options Expiry: Settlement at the Option Expiration Date
On the options expiry date, the final settlement is made between the buyer and the seller of the contract. There are mainly two ways by which settlement happens:
- Physical delivery – Generally, physical settlement happens in the case of commodities. The buyer and the seller agree to settle the contract by physical delivery. In this case, the seller of the contract delivers the quantity to the buyer and the buyer pays cash to the seller.
- Cash settlement– In this method of settlement, cash payment is exchanged between the two parties instead of the actual physical underlying security upon exercise of options.
Over the last few years, Stock exchange has started the expiry of options on a weekly basis as well. Weekly expiry of options is not available for all options. But, it is available for those stocks, ETF’s and indices which are most actively traded.
Trade Action before Options Expiry:
If you are a holder of the call or put option, you must be ready to take action on or before the expiry of the contract. You will get a reminder email before expiry or an alert when you will log in your brokerage account. Your broker will give you this reminder almost three times (although it varies from one brokerage house to another).
First email or alert will be in the first month of expiry, the second alert will be given on Monday before expiry and final will be in the morning of the expiry day.
In this way, a brokerage firm will let you remind option expiration date so that no trader misses or forgets to exercise their right.
On or before the expiry, if the option is In-the-money, you must either exercise or sell your option. If you are a call option holder, you will buy the option at the strike price. While if you are a put option holder, you will sell your option at the strike price.
On the other hand, if the option is out-of-money, on the date of expiry you would lose the whole money you had spent on the option means your option will expire worthlessly.
Options Expiration and Option Value
The options expiry date and its value both are related to each other. The value of an option increases with the longer expiry date. The longer the date of expiration of options, the more time it will take to reach the strike price, and finally it will have more time value.
As you know there are two types of options. One is call option and another is put option. The Call option holder has the right but, not an obligation to buy underlying security with a fixed price on or before the expiry of the option.
And put option holder has the right but, not an obligation to sell the underlying security on or before expiry with a fixed price.
It shows that both call option and put options have value only if it will be exercised on or before a specified date or expiry date. The holder of the option does not retain any right once the expiry period ends. In other words, we can say that the time value of an option does not exist after its fixed expiry date.
Options Expiration Effect On Stock Price
There is no direct impact of the options expiration on the stock price component. The decision that the options get expired or not is based on the set strike price and the current market price of the stock.
However, there could be some indirect impacts, especially from traders running high volume; for instance – the AMCs i.e. Asset Management Companies.
For instance, if an asset management company takes up an options contract in a semi or no-liquidity market, then the AMC might want to hedge at the same time.
For that, you might want to trade options directly in the underlying asset with high volume in order to give it a small nudge towards liquidity with an expectation that other traders treat this as some sort of a stock-movement signal.
If all work in the direction you expect, this will certainly impact the stock price!
Nonetheless, it is almost impossible for common retail traders to have an impact of such kind during their trades.
- The expiration date of an option refers to the last date on which an option contract is valid.
- For most of the stocks Quarterly, monthly and weekly expiration cycles available.
- Two types of the settlements happen on the date of options expiry, one is physical and another is cash settlement.
- Longer expiration date means the more time value of an option.
- Reminder E-mail or alerts for the date of expiry is given by the brokerage firms when you log in your brokerage account.
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