Options Expiration Explained

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Options Expiration Explained

Options can be dangerous.

They have a time limit.

That’s completely different than how stocks trade.

So if you’re going to trade options, you’re going to have to master the ins and outs of options expiration.

This guide will answer every single question

Why Options Expiration (OpEx) is So Important

If you come from a directional trading background (meaning long or short), then you probably only focus on where a stock or market is going.

But that is only one part of the option trading equation. It’s known as delta.

The true risks in the options market come from two things:

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Theta – the change of an option price over time

Gamma – your sensitivity to price movement

A failure to understand these risks mean that you’ll put your portfolio in danger. especially as options expiration approaches.

If you’re in the dark about the true mechanics of options expiration, make sure you read this before you trade another option.

How Does Options Expiration Work?

When it comes down to it, the financial market is all about contracts.

If you buy a stock, it’s basically a contract that gives you part ownership of a company in exchange for a price.

But options are not about ownership. It’s about the transfer or risk.

It’s a contract based on transactions.

There are two kinds of options, a call and a put.

And you have two kinds of participants, buyers and sellers.

That leaves us with four outcomes:

If you’re an option buyer, you can use that contract at any time. This is known as exercising the contract.

If you’re an option seller, you have an obligation to transact stock. This is known as assignment.

On the third Saturday of the month, if you have any options that are in the money, you will be assigned. This process is known as “settlement.”

The transaction in these options is handled between you, your broker, and the Options Clearing Corporation. You never will deal directly with the trader on the other side of the option.

If you are long options that are in the money, you will automatically begin the settlement process. If you don’t want this to happen, you will have to call your broker.

Why don’t Out of the Money Options get assigned?

Each option has a price that the buyer can buy or sell the stock– this is known as the strike price.

If it is “cheaper” to get the stock on the market, then why would you use the option?

If the stock is trading at $79, which makes the most sense.

Buying the stock on the market at $79?

Or using the option to buy the stock at $80?

The first one, of course.

So into expiration, these out of the money options will expire worthless.

What are the Options Expiration Dates?

Technically, expiration occurs on Saturday. That’s when settlement actually occurs. But since the market’s don’t actually trade on Saturday, we treat Friday as the effective expiration date.

For monthly option contracts, the expiration is the Third Friday of each month.

With the introduction of weekly options into the mix, we now have options that expire every single Friday.

The CBOE has a handy calendar that you can download and print for your desk.

Are There Exceptions?

There’s a handful of “goofy” expiration dates on specific options boards.

For monthly SPX options, they stop trading on Thursday, and the settlement value is based on an opening print Friday morning. These contracts are “cash settled” meaning there is no true assignment but instead you look at the intrinsic value of the options and convert it into cash.

Here’s where it can get weird. SPX weekly options are settled on Friday at the close. So if you are trading around OpEx with the SPX you need to check if it’s a weekly or monthly contract.

How do options trade at expiration?

When we look at options pricing, we generally follow a traditional model. We can look at the things that affect the options pricing, known as the greeks.

But when the market heads into options expiration, weird things can happen.

It’s very similar comparing traditional particle physics with what happens at the quantum level.

There’s a concept that I call the “gamma impulse.”

If you look at a call option into expiration, it has this risk profile:

Yup. It’s a Call Option.

We know that if the option is out of the money, it will have no directional exposure (0 delta), and if the option is in the money it will behave like stock (100 delta).

notice two different values for delta

The gamma of an option is the change of the delta relative to price.

So there is this discontinuity right at the strike price– and the gamma of the option can be represented by a “dirac function.” This is what I call a gamma impulse.

don’t get caught on the wrong side of this.

If you have an option that switches from OTM to ITM very quickly, your risks change drastically.

What if I don’t have enough cash to cover assignment?

This is where it gets interesting.

And this is why you need to be extra vigilant into expiration.

If you have a short option that goes in the money into expiration, you must fulfill that transaction.

If you don’t have enough capital, you will get a margin call on Monday.

You also have gap risk.

This happened to me back in 2007.

I had a pretty decent-sized iron condor in BIDU.

This was back before their 10:1 split.

I found on Saturday that the short options had expired in the money, and that I now had a sizeable long position on in BIDU.

Not Fun.

I was lucky enough to see BIDU gap up the following Monday and I exited for a gain.

But. never again. Make sure your books are cleared out of all in the money options if you don’t want to get assigned.

What if I’m short a call without stock?

If you have a sold call, you will be given a short position if you don’t own the stock already. This is known as a “naked” call rather than a “covered” call.

Margin to hold this short is determined by your broker, and to eliminate the short you will have to “buy to close” on that stock.

What about options pinning?

See my full guide on options pinning.

Can You Get Assigned Early?

There are two types of options: American and European.

With European-style options, you can’t get assigned early.

With American-style, you can get assigned whenever the option buyer feels like it.

Most options are American style, but you rarely have early assignment.

What if I don’t want to get assigned?

So you’re coming into options expiration with short options that are in the money.

And you don’t want to be short the stock or own the stock.

  • Solution #1: Never get down to options expiration with in the money options. Be proactive with your trades.
  • Solution #2: Close out the in the money option completely. This may be difficult into options expiration as the liquidity will dry up and you will be forced to take a worse price.
  • Solution #3: Roll your option out in time or price. These kinds of rolls, as detailed in my options trading course, will move your position into a different contract that has more time value, or is out of the money. These are known as calendar rolls, vertical rolls, and diagonal rolls.

A good rule of thumb is if your option has no extrinsic value (time premium) left, then you need to adjust your position.

How To Make Money Trading Around Expiration

Because of that “gamma impulse” we talked about earlier, the risks and rewards are much, much higher compared to normal options tarding.

There’s two groups of OpEx trades to consider: option buying strategies and option selling strategies.

Option buying strategies attempt to make money if the underlying stock sees a faster move than what the options are pricing in. The profit technically comes from the delta (directional exposure), but since it is a long gamma trade, your directional exposure can change quickly leading to massive profits in the very short term. The main risk here is time decay.

Option selling strategies attempt to make money if the stock doesn’t move around that much. Since you are selling options you want to buy them back at a lower price. And since option premium decays very fast into OpEx, the majority of your profits come from theta gains. Your main risk is if the stock moves against you and your directional exposure blows out.

Options Expiration Trading Strategy Examples

We do trade around OpEx at IWO Premium. Here are some of the strategies we use:

Weekly Straddle Buys

This is a pure volatility play. If we think the options market is cheap enough and the stock is ready to move, we will buy weekly straddles.

As an example, a trade alert was sent out to buy the AAPL 517.50 straddle for 5.25. If AAPL saw more than 5 points of movement in either direction, we’d be at breakeven. Anything more would be profit.

The next day, AAPL moved over 9 points, leading to a profit of over $400 per straddle:

This trade is risky because it has the opportunity to go to full loss in less than 5 days. Position sizing and aggressive risk management is key here.

Spread Sale Fades

When an individual stock goes parabolic or sells off hard, we will look to fade the trade by either purchasing in-the-money puts or by selling OTM spreads.

With the market selling off hard in December and the VIX spiking up, premium in SPX weeklies were high enough to sell them. So a trade alert was sent out to sell the SPX 1750/1745 put spread for 0.90:

Once the risk came out of the market, we were able to capture full credit on the trade.

Lotto Tickets

These are high-risk, high-reward trades that speculate strictly on the direction of a stock. Generally a stock will develop a short term technical setup that looks to resolve itself over the course of hours instead of days. Because of that short timeframe, we’re comfortable with buying weekly calls or puts. These trades are made in the chat room only, as they are fast moving and very risky.

These are just some of the trades we take within the IWO Premium Framework. If you feel that it’s a right fit for you, come check out our trading service.

Options Expiration

All options have a limited useful lifespan and every option contract is defined by an expiration month. The option expiration date is the date on which an options contract becomes invalid and the right to exercise it no longer exists.

When do Options Expire?

For all stock options listed in the United States, the expiration date falls on the third Friday of the expiration month (except when that Friday is also a holiday, in which case it will be brought forward by one day to Thursday).

Expiration Cycles

Stock options can belong to one of three expiration cycles. In the first cycle, the JAJO cycle, the expiration months are the first month of each quarter – January, April, July, October. The second cycle, the FMAN cycle, consists of expiration months Febuary, May, August and November. The expiration months for the third cycle, the MJSD cycle, are March, June, September and December.

At any given time, a minimum of four different expiration months are available for every optionable stock. When stock options first started trading in 1973, the only expiration months available are the months in the expiration cycle assigned to the particular stock.

Later on, as options trading became more popular, this system was modified to cater to investors’ demand to use options for shorter term hedging. The modified system ensures that two near-month expiration months will always be available for trading. The next two expiration months further out will still depend on the expiration cycle that was assigned to the stock.

Determining the Expiration Cycle

As there is no set pattern as to which expiration cycle a particular optionable stock is assigned to, the only way to find out is to deduce from the expiration months that are currently available for trading. To do that, just look at the third available expiration month and see which cycle it belongs to. If the third expiration month happens to be January, then use the fourth expiration month to check.

The reason we need to double check January is because LEAPS expire in January and if the stock has LEAPS listed for trading, then that January expiration month is the additional expiration month added for the LEAPS options.

Expiration Calendar

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Options Expiration | Everything You Need To Know

“Expiration” is a term that you will not hear a stock trader utter…why? Because when you own shares of stock, that ownership never expires (unless you choose to sell your shares of stock).

So why do options expire?

Unlike purchasing shares of stock, purchasing an option contract is generally used as a shorter-mid term investment. When you buy or sell an option contract (controlling 100 shares of stock), you must agree to an expiration date, as part of that contract.

As the buyer or seller of an option, you can choose which expiration cycle you would like to invest in. For most stock options, there are typically quarterly cycles, monthly cycles, and weekly cycles.

It is not vital to learn why expiration cycles occur in the weeks/months that they do (although we will touch on this a little bit in this post), but rather what is more important is understanding what expiration is and how to choose an expiration date because it becomes pivotal in determining whether or not a trade was a success or failure.

What Is An Expiration Cycle? A Brief History

Expiration cycles can be kind of confusing, so I’m going to do my best to break it down. 1973 is the year that the Chicago Board Options Exchange (CBOE) first started to allow equity trading. When they began, it was decided that when options are traded, there would be a total of four different months that each individual equity option could be traded during, each on a different cycle.

The CBOE in 1973

The typical increments for these options were 3 months, 6 months, 9 months, and 1 year. Typical cycles for an option would look something like this:

  1. January expiration, April expiration, July expiration, October expiration
  2. February expiration, May expiration, August expiration, November expiration
  3. March expiration, June expiration, September expiration, December expiration

Expiration Cycles Change – More Cycles!

Options gained popularity through the 70s and 80s as a way for investors to hedge their stock positions in the shorter term. As a result of this, in 1990 the CBOE made a change to the rules so that every stock option would have an expiration cycle in the nearest two months.

From then on, all equity options would have what was deemed a ‘front month’ (the closest month – generally the current month) and a ‘back month’ (the month proceeding the front month), which made the expiration cycles only slightly more complex.

Another development to expiration cycles spawning from the rising popularity of options in the 90s was the birth of a new type security, called LEAPS.

Long Term Equity Anticipation Security – Even More Cycles!

Long Term Equity Anticipation Security (LEAPS) were introduced as a way to make longer-term investments in stock options (things like indices did not have LEAPS until more recently).

So how long can an option contract actually be with LEAPS?

A LEAPS can expire up to 3 years from the current expiration cycle date, making the option as an instrument, a viable longer-term trading strategy for investors (I use ‘longer’ loosely because its very subjective and based on an investor’s trading style – i.e. for a day trader, 3 years would be an eternity, but for a buy and hold style trader, it’s short-term). LEAPS added on additional expiration cycles to underlyings, extending the investing calendar from 1 to 3 years.

Where does that leave us?

After LEAPS were introduced, expiration cycles got quite a bit more complex. Like previously mentioned, it’s not necessary for you to understand the ins and outs of why expiration cycles occur at the frequency/times they occur at. With trading softwares, it’s no longer necessary to memorize or understand why certain underlyings have certain expiration cycles and other don’t. What’s most important is understanding what expiration cycle choices you have to make.

If you do want to know more about how the cycles currently work after to the addition of front month/back month and LEAPs cycles, investopedia does a great job breaking it down here.

Why Is Options Expiration So Important?

In the most basic sense, expiration is important because it sets a timeframe for your trade. Whether or not a trade is going in the right direction and how much time left until that option expires define what profit or loss you will incur as an investor.

This chart shows how time decay (theta) impacts the price of an option.

How many days you have left until an option expires is called days to expiration (DTE). During the time between the placement of the trade and the expiration date, a variable called theta (time decay), will determine if your trade is profitable or not. As the amount of time until your option expires – theta decay – decreases, this is favorable to the seller of the option, and not the buyer.

One last reason expiration is so important is due to its relation with stock assignment.

One fear that keeps some traders from placing their first options trade is the fear of being assigned stock (especially if you have a smaller account with funds less than that of what 100 shares of a stock would cost). Don’t let this fear stop you from placing your first options trade. It’s not that scary, I promise!

If you sell an option (naked or as part of another strategy – i.e. Iron condor) and that option is in the money when the option expires, you will be assigned stock. If you buy an option, you will never automatically be assigned stock. As the buyer, you always have the right, but not the obligation, to purchase the stock via the option you invested in.

How To Choose An Expiration Date

Choosing an expiration can be difficult, so here are some things to keep in mind when choosing an expiration date.

When picking an expiration date, your trading style should guide what expiration you choose. For example, if you day trade, you will probably always use the nearest expiration cycle. A premium seller may want to go farther out and find an expiration cycles with about 25-50 days to expiration, while someone who does technical analysis may adjust their DTE according to what their charts are telling them (which can vary from underlying to underlying).

Are you a premium seller (someone who sells options to collect premium)? tastytrade has done a ton of research into the mechanics of selling premium. After countless studies, the research team has found that you stand the best chance of profiting when you sell options with 25-50 days to expiration.

As mentioned before, most stock options have weekly, monthly, and quarterly cycles. Something to keep in mind when choosing an expiration date is what cycle the option is in, as this can have an impact on how liquid the underlying is. Weekly cycles tend to be less liquid than monthly/quarterly, so you may have a little trouble getting out of a trade in a weekly expiration cycle. Always keep liquidity in mind when choosing an expiration.

That may leave you wondering: why would you choose to invest in the weekly expirations if those options are generally more illiquid than monthly expirations?

There are several answers to that question, but the most popular are that weekly expirations would fit better in your strategy (if you invest in options that are between 1-10 trading DTE, then weekly expirations would provide you more opportunities to invest) and weekly expiration cycles are commonly used for earnings trades.

Earnings are another important consideration when determining an expiration date (along with dividends for similar reason). Earnings are a binary event, meaning that one of two outcomes can occur. the price can go up or down after earnings are announced and many times, earnings cause large swings in an underlying’s price and there is a corresponding ‘crush’ in the options volatility.

If you put a position on and there are earnings before that position expires, beware of the possibility of the changes in price caused by the earnings announcement. The amount that an underlying may go up/down after an earnings announcement is called the expected move. What the expected move does is quantify the potential move using statistics and historical data, ultimately giving you a price range that the underlying is expected to stay between.

Understanding Expirations On tastyworks’ Trade Page

Understanding the concept of expiration is one thing, knowing how to decipher it within a trading platform can be a whole new ballgame (due to shorthand terminology).

Anytime you set up a trade on tastyworks, you will need to pick an expiration cycle. One of easiest ways to do this is using the expiration buttons on the trade page pictured below.

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