Options trading can seem complicated, especially when it comes to choosing expiration dates. Understanding how expiration dates work and selecting the right one can make all the difference in your trading strategy.
In this article, we’ll dive into what option expiration dates mean, what happens when they arrive and how to choose the best one to meet your goals.
Here’s everything you need to know.
What is an expiration date for options?
An options contract grants the holder the right — but not the obligation — to buy or sell an underlying asset, usually a stock, at a specified price before the contract expires. The expiration date marks the last day you can exercise this right.
After the expiration date, the option becomes worthless, meaning you can no longer exercise or trade it.
Options contracts come in various types, and their expiration dates can significantly impact their value and potential profit or loss.
As an option’s expiration date approaches, its value decreases due to time decay. This means that the time value, or the portion of the premium tied to the remaining time, diminishes. From an investor’s standpoint, this accelerated decline in value happens because there’s less time to exercise the contract before the option expires.
Option types based on expiration dates
When evaluating potential options positions, most traders consider both the current price of the option and the time remaining until its expiration date.
Options come in different formats, depending on their expiration timelines.
Here’s a quick rundown of the main types:
- Zero-day options: These expire within one trading day and are often used for short-term speculative plays. Zero-day options are considered high-risk due to their quick turnaround.
- Weekly options: Also known as “weeklys,” these options generally expire on Fridays. These are suitable for short-term strategies because they allow for frequent trading opportunities.
- Monthly options: Standard options expire on the Saturday after the third Friday of each month. They’re popular among traders looking for a balance between time decay and flexibility. They’re also considered the most common type of option.
- Quarterly options: These options align with the end of the financial quarter and are widely used in certain indexes and ETFs.
- LEAPS (Long-Term Equity Anticipation Securities): These options have expiration dates of up to two years from issuance, allowing investors to hold them over a longer period with less time decay.
The time remaining until an option’s expiration directly impacts its premium. Longer-term options tend to command higher premiums because they offer more time for the underlying stock’s price to move favorably.
As an option nears expiration, finding a willing buyer can become challenging, making it harder to exit a position.
Investors often use options with different expiration dates to strategically manage risk and capitalize on market volatility.
What happens when an option expires?
When an option expires, its value depends on whether it’s in the money (ITM) or out of the money (OTM).
In the money
Both call options and put options can expire in the money.
- In-the-money call option: You can buy the stock below its current market price.
- In-the-money put option: You can sell the stock above its current market price.
If a call option is in the money, it means the underlying stock’s price is above the strike price when the contract expires, allowing the holder to buy at a lower price.
The call holder can then either exercise the option by buying the stock at the lower strike price and selling it at the higher market price, or sell the option itself to another investor before it expires.
To profit from a call option, the premium paid must be less than the difference between the stock price and the strike price when the contract expires.
On the other hand, a put option is considered in the money when the market price of the underlying stock is lower than the option’s strike price. The put owner can then either exercise the option or sell the option contract itself to another investor.
A put owner makes money on the contract when the premium paid is lower than the difference between the strike price and stock price when the option expires.
Many brokers automatically exercise in-the-money options at expiration so holders don’t have to manually exercise their contracts.
Out of the money
Out-of-the-money options expire worthless. In the case of an OTM call, the stock’s price is below the strike price, so exercising would mean paying above-market rates for the stock — something no trader wants.
Likewise, an OTM put option’s strike price sits below the stock’s market price, making it unprofitable to exercise. In these cases, the holder loses any premium they initially paid for the option, as it no longer has any financial benefit at expiration.
Finally, there’s also the rare case of at-the-money options, where the stock’s price matches the strike price exactly. Since there’s no intrinsic value in these cases, at-the-money options also usually expire worthless.
The best brokers for options trading give investors tools to quickly identify which options are in the money and which are out of the money.
How options are valued at expiration
At expiration, options are valued solely on their intrinsic value since their time value has dropped to zero. Remember, an option’s intrinsic value is the difference between the price of the underlying stock and the option’s strike price.
- Intrinsic value: The real value of the option if it were exercised immediately. For a call, this is the stock price minus the strike price if it’s in the money. For a put, it’s the strike price minus the stock price.
- Time value: Also known as extrinsic value, time value reflects the market’s expectation of future price movement and volatility. This premium represents the price investors are willing to pay for the potential profit the option offers before it expires. As expiration nears, time value decays, so that at expiration, it’s gone entirely.
Picking the best options expiry date
Choosing an expiration date depends on your trading strategy, risk tolerance and the market’s current outlook. Here’s a list of considerations to help you pick the best date for your options.
- Time horizon: Match the expiration date to your investment timeline. If you’re planning for short-term movements, weekly options might work. For longer-term plays, monthly or quarterly options might be better.
- Volatility considerations: Shorter expirations are more sensitive to volatility. If you expect high volatility, shorter dates can offer quick gains, but they’re also risky.
- Time-decay sensitivity: The closer the option is to expiration, the faster it loses time value. If you’re trading short-term options, be aware of rapid time decay and take into account your ability to act quickly.
- Market conditions: Consider overall market trends and specific events, like earnings announcements. If you expect an event to impact the stock price, align your expiration date to capture the movement.
- Strike price proximity: Closer-to-the-money options may expire in the money, offering a better chance to exercise the contract, but they may be more expensive. Further-from-the-money options might be cheaper, but you may be less likely to exercise the option profitably.
Bottom Line
Understanding expiration dates is key to mastering options trading. While short-term options can provide quicker returns, they carry more risk. Longer-term options give you more time to act but are generally more expensive.
By carefully choosing an expiration date that aligns with your strategy and tolerance for risk, you’ll position yourself for a better chance of profitable trades.
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