Do Stock Options Expire?
O ne of the key differences between options and stocks is that options come with a predetermined expiration date. When purchasing an options contract, it’s important to understand the relationship between an option and its expiration date. Let’s dive into more about the details of options expiring.
- Options are contracts that give you the right, but not the obligation, to buy or sell 100 shares of an underlying asset at a set price on or before a predetermined expiration date.
- Unlike stocks, all options contracts have an expiration date. An option expires on the third Friday of the contract’s month unless there is a national holiday. Then, it will expire on the third Thursday of the contract’s month.
- An option’s expiration date is the last day you can exercise your rights. You can decide to exercise the option, close the position, or let your worthless contract expire.
- Buying and selling options is a common way investors enhance their portfolios and limit their risk.
What Is an Option?
An option is a contract that gives you the right, but not the obligation, to buy or sell an underlying asset at a set price on or before a predetermined expiration date. Options are a type of derivative, in that their value is directly linked to the value of an underlying asset, such as stocks.
There are two main types of options: call options and put options. With call options, the holder of the option has the right to buy the underlying asset at a set price within a predetermined timeframe. With put options, the holder of the option has the right to sell the underlying asset at a set price within a predetermined timeframe.
A More In-Depth Look at What Options Entail
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Every options contract represents 100 shares of the underlying security. In order to have the right to buy or sell, you need to pay a premium fee for each options contract you want. The premium you pay is based on the strike price, which is the price for buying or selling the asset on or before the options’ expiration date. Another factor that impacts your premium cost is the expiration date of the contract.
When deciding to buy or sell an option, you need to look at the direction of your underlying asset. Traders typically buy a call option when they expect the underlying asset’s price to increase over the lifetime of the contract. If a trader anticipates the market to fall, they may decide to buy a put option contract. When the market goes in a favorable direction, these types of contracts can give you a decent profit.
What Is an Options Expiration Date?
The expiration date of an options contract is the final day you can exercise your rights. Prior to this date, you need to decide if you want to exercise the option, close the position, or let your worthless contract expire. After this date has passed, your contract rights cease to exist, which is why you need to be proactive about your final decision.
With some options, there is an automatic exercise provision. Your rights are automatically exercised if your option is in the money, meaning it has intrinsic value. If you decide you don’t want to exercise your rights, then you would need to close out or roll your position.
When Is Options Expiration?
An option expires on the third Friday of the contract’s month. If the Friday falls on a national holiday, the new options expiry day would be the Thursday before the third Friday.
When you can exercise your rights depends on where you purchase your options contracts. With American options, you can exercise your rights anytime before the expiration date. In contrast, a European option only gives you the power to exercise your rights on the actual expiration date. By exercising, this means that you buy or sell your underlying asset.
How Is Theta Related to the Options Expiry Dates?
When determining the risk factor of an options contract, it’s useful to look at the Greeks. They consist of delta, gamma, vega, and theta — each one of these measures a different dimension of risk related to your contract.
When assessing the risk of time, you should look at theta in particular. Theta represents an option’s time decay, which is the rate of change between the option price and time. As your options contract gets closer to its expiration date, theta tells you how much the price of the option would decrease.
Things to Know When Trading Options
When trading options, keep these things in mind:
- The longer you wait, the more value is lost. That’s because, generally, the closer you get to an options expiry day, the more value it loses. Look at theta to determine the rate of time decay on your contract.
- Never forget your expiration date. If you forget to exercise your rights, expired stock options become worthless.
- Buying options isn’t the best way to own stock. Once the option expires, you no longer have a hold on that stock. Buying the stock outright may be the better choice if you want to hold onto it for a while and have ownership rights.
- Use the Greeks to calculate your risk. Options trading tends to be for more seasoned traders since you need to assess risk measurements to understand what you’re getting into. Knowing how volatile your underlying asset is can help you make better trades.
- The Greeks are theoretical. They simply reflect on how the market is anticipated to change. There is never a full guarantee that these predictions will be correct.
- Know the lingo. “In the money” means your options contract holds intrinsic value. “Out of the money” means it has no intrinsic value, only extrinsic value. “At the money” means the strike price is the same as the price of the underlying security.
- Understand your financial goals. What is your purpose for trading options? Many investors use them to enhance their portfolios and limit their losses.
The Pros of Buying and Selling Options
When you have a good grasp on what the expiration of options means, this type of trading comes with a few benefits, such as:
- Reduced risk: Many investors add options to their portfolios to balance their risk level. For example, when you buy a put option, you can try to sell the underlying options contract at the strike price even if it happens to be above the current market price.
- Potential profits: If the market moves the way you expect it to, you can buy or sell an underlying asset at a better price and make a substantial profit.
- Limited loss: Investors like options since the most they can lose is what they paid for the premium. For instance, if you purchase a call option and the underlying asset’s price doesn’t rise, you don’t have to buy that asset. You could simply let the contract expire.
The Cons of Buying and Selling Options
Remember that every type of trading has some potential drawbacks. Keep these disadvantages of buying and selling options in mind:
- Premium payment: Having the right to buy or sell an option comes at a price. You must pay a premium cost to get started.
- Reduced availability: Not every stock has an options contract linked to it. You may find that some of your favorite companies do not have them.
- Time: The expiration of options is something every options trader needs to consider. As your contract gets closer to expiration, it loses its value due to time decay.
- Commissions: The commission rate for options tend to be higher than many other trades. Even if you do make a profit, remember that you’ll need to give a certain percentage of it to your broker.
How to Start Trading Options
- The long call: This is when you expect the price of an underlying asset to rise, and you hold call options. When the value of shares rises above your pre-negotiated strike price, you can make a profit.
- The long put: If you think the price will fall, buying a put option can lower your investment losses. You could sell at your strike price, which is higher than the market price.
- The short put: If you think the price will stay the same or increase due to expiration, you would sell a put option and become an option writer. When the option becomes worthless, the put seller keeps the premium.
When trading options, the key takeaway is that they differ from regular stocks because they have an expiration date. Along with this, options do not give you the same ownership you would have if you purchased the stock directly. When deciding whether to exercise your rights, consider the expiration date of your option and what it entails for the value of your contract. As with any investment, trading options come with a risk that you must be aware of before making any big decisions.