So, what’s the big deal about expiry dates anyway? When you purchase an option, you’re essentially buying the right to buy or sell a stock at a specific price, known as the strike price. However, this right doesn’t last forever—it has an expiration date. When that date rolls around, a few things could happen depending on the type of option, its moneyness (yep, that’s a real term), and your broker’s policies.
In-the-Money and Out-of-the-Money: It Makes a Difference
The first thing you need to understand about what happens when options expire is whether they’re “in-the-money” (ITM) or “out-of-the-money” (OTM). Simply put, if executing the option could make a profit, it’s ITM. If it wouldn’t be profitable, it’s OTM.
For call options, an option is ITM if the market price of the stock is higher than the strike price, and it’s OTM if the market price is lower.
For put options, it’s the other way around: it’s ITM if the market price is lower than the strike price, and OTM if the market price is higher.
So, What Happens When Options Expire?
If your option is ITM on the expiration date, it will generally be automatically exercised by your broker. This means you’ll buy or sell the underlying stock at the strike price. But don’t worry; this doesn’t mean you’ll be stuck with a bunch of stock you don’t want. You can always sell the stock right after you buy it, potentially for a tidy profit.
If your option is OTM on the expiration date, then it will generally just expire worthless. This means you don’t get the stock, but you also don’t lose any more money beyond the premium you paid for the option.
However, these general rules aren’t set in stone. It’s important to understand your broker’s specific policies, as they may have different procedures for handling options at expiry.
Examples of Options Expiring
Let’s make this all a little more real by looking at some examples.
Example 1: ITM Call Option You bought a call option with a strike price of $50, and it’s now expiry day. The current market price of the stock is $55. This option is ITM because the market price is above the strike price. So, you exercise the option, buy the stock for $50, and can immediately sell it for $55, scoring a nice profit.
Example 2: OTM Call Option On the other hand, let’s say the market price of the stock is $45 on the expiration date. This option is now OTM. If you exercised it, you’d buy the stock for more than it’s worth, which doesn’t make much financial sense. So, in this case, the option expires worthless, and you’re out the premium you paid for it.
European vs American Options
You’ve been cruising along in the options world, and now you hit the European vs American speedbump. What’s this all about? Well, it’s about when you can exercise your options.
European options can only be exercised on the expiration date. This means you have to wait until the final day to see if your option is ITM or OTM. The suspense!
American options, on the other hand, can be exercised anytime before or on the expiration date. This gives you a bit more flexibility, as you can cash in your option as soon as it becomes profitable.
The Role of Theta in Options Expiration
Theta, also known as time decay, plays a significant role in what happens when options expire. As an option gets closer to its expiration date, theta generally increases, which means the option’s value decreases. This is because as time runs out, there’s less chance the option will become ITM if it isn’t already.
So, if you’re an option buyer, time is not on your side. But if you’re an option seller, theta is your best buddy because you want the option to decrease in value and eventually expire worthless.
The Last Trading Day: What to Expect?
As the expiration date approaches, you can expect a higher trading volume for that option. This is because traders are trying to close their positions, either to lock in profits or to cut losses. Remember, though, that the last trading day for an option might not be its expiration day. Most options stop trading the third Friday of the month, but they don’t officially expire until the following Saturday. So keep an eye on your calendar!
Remember, options expiration doesn’t have to be a high-drama, nail-biting event. With a solid understanding of what happens when options expire, you can approach that date with confidence and a game plan. So, watch that clock, keep learning, and make your options work for you. Happy trading!
Frequently Asked Questions (FAQs)
What happens if I don’t sell my options on expiry? If you don’t sell your options on expiry and they are in-the-money (ITM), they will typically be automatically exercised, assuming you have the necessary funds or shares. If they are out-of-the-money (OTM), they will simply expire worthless.
How much do you lose if your option expires? If your option expires out-of-the-money, you lose the premium you paid to buy the option. That’s the maximum loss you can incur.
Do options automatically sell when they expire? No, options do not automatically sell when they expire. If they are in-the-money, they will usually be automatically exercised by your broker, unless you previously instructed them not to.
What happens when a call option expires below the strike price? If a call option expires below the strike price, it is out-of-the-money and will expire worthless. You will lose the premium you paid for the option.
Is it bad to let an option expire? Letting an option expire isn’t necessarily a bad thing. If it’s out-of-the-money, it will expire worthless and you’ll lose the premium you paid. But if it’s in-the-money, it will typically be automatically exercised, assuming you have the necessary funds or shares.
What happens if there are no buyers for an option on expiry day? If there are no buyers for an option on expiry day, you won’t be able to sell your option. However, if it’s in-the-money, it will usually be automatically exercised.
Can I buy an option the day it expires? Yes, you can buy an option on the day it expires, but it may not be a good idea because the option’s time value will be very low, making it unlikely to become profitable.
How long can you keep an option? You can keep an option up until its expiration date. The length of an option contract can range from a week to several years, depending on the type of option.
Why covered calls are bad? Covered calls aren’t inherently bad, but they do have risks. The main risk is that you limit your upside potential. If the stock price skyrockets, you won’t benefit beyond the strike price of the call you sold.
Can I hold options after expiry? No, you cannot hold options after expiry. They will either be exercised if they are in-the-money or expire worthless if they are out-of-the-money.
How late can you sell options? You can sell options up until the market closes on the day they expire.
What happens when a call option goes above the strike price? When a call option goes above the strike price, it becomes in-the-money. If it’s still above the strike price at expiration, it will typically be automatically exercised.
Will my call option expire worthless? Your call option will expire worthless if the stock price is below the strike price at the time of expiration.
Why do option buyers lose money? Option buyers can lose money if the stock price doesn’t move in the direction they anticipated, or if it doesn’t move enough to cover the premium they paid for the option.
Can I still make money on a call option before it hits the strike price? Yes, as long as the stock price is moving towards the strike price and the option’s time value is still high, you can sell the option for a profit.
What is the most profitable option strategy? The most profitable option strategy depends on your market outlook, risk tolerance, and investment goals. However, strategies like selling covered calls, buying protective puts, or using spreads can be profitable under the right conditions.
What is the best time of day to buy options? There’s no universally agreed-upon best time to buy options, but some traders believe that the market is more liquid during the first and last hour of trading, which may result in better pricing.
What happens when a put option expires in the money? When a put option expires in-the-money, it will typically be automatically exercised. You will sell the underlying stock at the strike price, which will be higher than the current market price.