Expiration Date Basics for Options (Derivatives) (2024)

An option's expiration is the specific date and time when the option contract becomes invalid. The expiration date is critical for both the option's buyer and seller. For American options, the buyer can exercise the option at any point up to and including the expiration date. For European options, the holder can only exercise the option on the expiration date itself.

The expiration date is crucial for an investor when dealing with options since it significantly affects the option's value and the strategies an investor may employ. The date is almost always clearly stated in the option contract. Options can have various expiration periods, ranging from as short as one day to several months or even years.

Most equity options are American style, while index options, like those for the S&P 500, are European style.

Option Types Based on Their Expiration Date

Options’ expiration dates take several forms. European-style options can only be exercised on their expiration date, while American-style options can be exercised any time before their expiration date. Here are some different lengths of time available:

• Monthly Contract Expiration: These are the most traditional and commonly traded options and typically expire on the third Friday of the contract month in the U.S. They offer a balanced approach for traders not looking for extremely short- or long-term commitments.
• Weekly Contract Expiration: These are known as “weeklys” and expire at the end of the trading week. Weeklys are well suited for traders looking to capitalize on short-term market movements without the commitment of a monthly contract.
• Daily Contract Expiration: These options expire at the end of the trading day purchased. This expiration date is ideal for traders focusing on intraday market events, and the option premiums are highly sensitive to daily market volatility.
  
• Long-Term Equity Anticipation Securities (LEAPS): These are designed for long-term investment strategies, with expiration periods extending to two years. LEAPS are available for a wide range of equities and indexes and are for investors wanting long-term hedging or speculative opportunities.
  

Each type of expiration caters to different trading strategies and risk appetites, making it essential to understand their characteristics.

Monthly Contract Expiration

One of the most commonly traded types of options has monthly expirations. These contracts expire on the third Friday of each month and are considered the standard for many individual investors and traders. Here are the monthly contract's key features:

• Predictability: Monthly options provide a consistent, regular trading cycle that many investors find appealing for planning longer-term strategies.
• Liquidity: Since monthly options have been around longer than their weekly counterparts, they often have higher liquidity, meaning entering or exiting positions is easier.
• Variety: Monthly options are available on a wide range of underlying assets, from stocks and exchange-traded funds to indexes and commodities.
• Lower time decay: Time decay is generally lower for monthly options than weekly options, offering a slower rate of premium erosion.
• Strategic planning: The longer life span of these options allows for greater flexibility in creating various options strategies.

Weekly Contract Expiration

Weeklys offer a faster pace of trading. Unlike the standard monthly options that expire on the third Friday of each month, weeklys typically expire every Friday, providing four or five opportunities to trade in a single month. Here are some of the weeklys' key features:

• Flexibility: Weeklys allow traders to tailor their strategies to specific events, such as earnings announcements, economic data releases, and geopolitical events.
• Lower premiums: Since they have a shorter life span, weeklys normally have lower premiums than their monthly counterparts, making them more affordable.
• Higher time decay: Time decay is more rapid in weekly options. Theta, one of the Greeks discussed below, is generally higher, meaning the option's value erodes more quickly as expiration approaches.
• Quicker turnaround: The short life span of weeklys allows traders to react swiftly to market movements, though this has higher volatility and risk.

Daily Expiring Options

Daily expiring options, also called zero days to expiration options (0DTE), offer the ultimate in short-term trading opportunities, generally expiring at the end of each trading day. These are the go-to for traders looking to profit from intraday and overnight market movements. Here are some of their key features:

• High liquidity: Daily options typically experience high trading volumes, especially on actively traded underlying assets, leading to tighter bid-ask spreads.
• Extremely short life span: These options expire at the end of each trading day, making them ideal for day traders or those looking to hedge short-term positions.
• Rapid time decay: Time decay is at its peak, with the option losing value rapidly as the trading day progresses.
• Intense volatility: Daily options can be highly sensitive to news and market fluctuations, making them potentially riskier and more rewarding.

How Options Are Valued at Expiration

The expiration date affects the option's price or premium. Generally, options with later expiration dates are more expensive because of the increased time value. This gives the holder a longer period to benefit from favorable price movements in the underlying asset.

The value of an option is generally derived from its intrinsic value and time value. The intrinsic value of an option is the present value of the derivative. It is the difference between the option's strike or exercise price and the current market price for the underlying asset. The intrinsic value is calculated for a call option by taking the underlying asset's current price and subtracting the strike price. The intrinsic value of a put option is the strike price minus the underlying asset's current price. If the result is negative, the option's intrinsic value is zero. The other component of an option's value is time value. This represents the extra premium that traders and investors are willing to pay for the option based on its potential to make a profit before the option expires.

As the option approaches its expiration date, the time value normally decreases, a phenomenon known as time decay. Time value accounts for the risk or uncertainty associated with holding the option over a period.

The value of an option at expiration is discussed in terms of its “moneyness,” which is the relationship between the underlying asset's market price and the option's strike price. Three common terms used for the moneyness of options at expiration are in-the-money (ITM), at-the-money (ATM), and out-of-the-money (OTM). Other names used for the value of options at expiration describe them as: “near-the-money” is either slightly ITM or OTM, and “deep-in-the-money” is highly profitable while “deep-out-of-the-money” can only be exercised at a significant loss.

Understanding these outcomes is essential for traders and investors to effectively manage their positions and expectations. Whether you're holding an ITM option with intrinsic value or an OTM option that is likely to expire worthless, knowing what to expect can help you make better-informed decisions as you navigate the complexities of options trading.

What Happens When an ITM Option Expires?

When an ITM option expires, the outcome depends on the type of option and the holder's preferences. For call and put options, most clearinghouses automatically exercise any expiring ITM options since the holder would almost always buy the underlying stock at the option's strike price. Some traders may prefer to manually exercise their options before expiration either to pocket a gain early or for other strategic reasons.

What Happens When an ATM Option Expires?

When an ATM option expires, it normally has no intrinsic value and is not automatically exercised since the option's strike price is equal to the underlying asset's value. Often, traders holding ATM options sell them before expiration to capture any remaining extrinsic value or time premium. However, given that the time value diminishes as the option approaches its expiration date, the opportunity to do so is quite limited.

What Happens When an OTM Option Expires?

OTM options have a strike price not favorable given the current market price of the underlying asset. Hence, they usually expire worthless. Unlike ITM options, OTM options will not be automatically exercised. Holders of these options often let them expire, though they could try to sell them to recoup some of the initial premium paid, which is likely to be minimal as the expiration date approaches.

How to Pick the Best Options Expiry Date

Choosing the best option expiry date is a decision that depends on your trading and investment strategy, market conditions, and your risk tolerance. Selecting the optimal expiry date for an options contract is critical for your strategy's success. Here's what's often considered in choosing an expiry date:

• Trading strategy alignment: The choice of expiry date should align with your overall strategy. A weekly option is likely best if you're looking to capitalize on short-term earnings announcements. Alternatively, LEAPS would be more suitable for hedging long-term investments.
• Market conditions: Understanding the market's mood can help you to determine the correct expiry date. Short-term options might have higher premiums and increased risk in a volatile market. Conversely, in a stable market, longer-term options likely have lower premiums and less risk.
• Risk tolerance: Shorter-term options are generally riskier and offer potentially higher returns. If you have less risk tolerance, options with further-off expiry dates allow more time for the market to move in the direction you would need.
• Liquidity considerations: Options with closer expiry dates usually have higher liquidity. This can make entering and exiting positions easier and more cost-effective.
• Cost and premium: Short-term options are generally cheaper but can be subject to rapid time decay, while long-term options are more expensive upfront but offer more time for your strategy to unfold.
• Volatility assessment: Implied volatility can significantly affect an option's price. If volatility is expected to increase, an option with an expiry further off is more likely to be chosen to capitalize on higher future premiums. Conversely, a closer expiry could be beneficial if volatility is expected to decrease.
• Option Greeks: Understanding the Greeks, discussed below, can help you unpack how an option's price will change over time so you can choose an expiry date that maximizes your strategy's potential.

By carefully considering these factors, you can choose the expiry date best suited to your objectives, risk profile, and market outlook.

Expiration Dates and Volatility

An option's expiration date and its volatility are closely connected, each influencing the other in ways that significantly affect an option's premium. Thus, understanding the complex relationship between an option's expiration date and its volatility is crucial for effective risk management and options investment strategy. Knowing how these factors interact can provide an edge if you're looking to capitalize on market volatility or hedge against it.

When you buy an option, the following are the knowable factors that affect its price: the current price of the underlying asset, the strike price, the interest rate if borrowing, the type of option (call or put), the time to expiration of the option, and any dividends on the underlying asset. Volatility is the one left out as the main unknown.

Volatility is therefore crucial for option prices. In essence, volatility measures how much the underlying asset's price varies during a specific period. Two types of volatility are important when considering options and their contract expiration:

Historical volatility: This is the record of fluctuations in the underlying asset's price, giving you a context to assess future volatility. Suppose you're looking at the stock of Company A, and you calculate that over the past 30 days, the stock has been between $40 and $50. After further calculations, you determine that the historical volatility for this period is 20%. Checking further, you find that the volatility for the past week is 30%, meaning it's more volatile than usual. This could indicate future prices, but since it's based on past behavior, it may tell you only where it's been, not where the stock's volatility is going.

Implied volatility: This is a forward-looking estimate of how much the market thinks the underlying asset price will move in the future. Options with high implied volatility have higher premiums, and low implied volatility goes with lower premiums. Of course, an option's price is not guaranteed to follow the predicted pattern. Nevertheless, evaluating what other investors are doing with the option is helpful since implied volatility is directly correlated with the market's view, which affects the option price.

The higher the volatility, the greater the price swings of the asset and the higher the price for the associated options. When an option's underlying asset has a more volatile price, the potential payoff from owning the option increases: the greater the risk, the greater the reward. Thus, option buyers are often willing to pay a higher premium for options on volatile assets. Short-term options are generally more sensitive to immediate market events, causing higher volatility and premiums. Alternatively, long-term options like LEAPS are less susceptible to short-term market fluctuations but have greater long-term volatility.

Strategies like buying options ahead of earnings announcements or during market uncertainty try to profit from volatility. Conversely, selling options in a low-volatility environment should offer lower risk, though it also likely has a lower return.

Suppose Company A is scheduled to release its quarterly earnings report next week. Since this will likely impact its stock price, the market expects more volatility in the near future, which is then reflected in the options you can get on its stock. Looking up a call option for Company A, you see a strike price of $50 and an expiration one month away, making the option premium relatively high. Using an options prices model, you calculate the implied volatility at 40%, which is much higher than the 20% historical volatility and even higher than the previous week's bump in volatility. The increased implied volatility reflects anticipation in the market for increased stock price fluctuations surrounding the earnings report. For this reason, other investors are willing to pay a premium for this option, given the higher likelihood that Company A's stock price will move significantly, thus offering the potential for a more substantial payoff.

Investors often use options with different expiration dates to strategically hedge against volatility. Understanding how it affects options prices can help you manage risks better and potentially improve your options strategy.

Expiration Dates and Options Greeks

Options Greeks, or simply “Greeks," are tools, each known by a Greek letter, that help calculate how the price of an option is likely to change in response to different financial variables. They're part of a well-known method (the Black-Scholes model) for calculating the value of an option, and each Greek focuses on a different factor influencing that value.

• Delta: This gauges how much an option's price will change as the underlying asset does, helping to predict if the option will earn a profit at expiration. Delta also helps assess directional risk. Positive, negative, and neutral deltas have long (buy), short (sell), and neutral market assumptions, respectively.
• Gamma: This measures the delta's rate of change. Gamma is highest for ATM options and lowest for those expected to be deep OTM or ITM. It suggests how the delta will change as the market moves and is an essential metric for traders who are delta-hedging their positions.
• Theta: This Greek measures time decay—how rapidly an option's price will decrease as it approaches its expiration date. The chance of an option being ITM decreases with time, so theta is generally negative for more extended options. This makes theta important to know when choosing an expiry date.
• Vega: The "V" in vega represents volatility. Vega indicates the estimated change in the option price in response to shifts in implied volatility; a high vega suggests that the option's value is likely to be more variable. When implied volatility decreases, those selling options tend to gain, while option buyers see the opposite effect. Implied volatility is influenced by trading activity in the options market, and an influx of buyers drives up option prices and raises implied volatility.
• Rho: This measures the sensitivity of an option's price to changes in interest rates, making it helpful in considering long-term options like LEAPS.

Understanding the Greeks allows traders and investors to make more exacting decisions, from selecting the correct expiry date to managing risk and optimizing potential returns.

Example of Options Greeks

Suppose a trader wants to buy a call option on Company A's stock, anticipating that it will increase in the next month. The current stock price is $50, the option's strike price is $55, and the option expires in 30 days.

The trader uses the delta to gauge the likelihood of the option expiring ITM. The option has a delta of 0.4, suggesting that for every $1 increase in the stock price, the option will increase by $0.40. A delta of 0.4 also implies a 40% chance that the option will expire ITM. The trader keeps an eye on gamma to anticipate changes in delta. The option's gamma is 0.1, indicating how much the delta will change for every $1 change in the stock price. If the stock moves up by $1, the new delta would be 0.5.

Theta is calculated as -0.05, meaning the option will lose $0.05 in value each day in time decay. Traders know that holding the option too long will erode its value, so they should plan to reassess the position before the option's expiration. The vega is 0.2: for every 1% increase in implied volatility, the option price will increase by $0.20. If the trader expects volatility to increase, this could add value to the option. Since interest rates are relatively stable, the trader might not focus on rho for such a short-term option.

Given these Greeks, the trader decides to buy the call option. The trader will closely monitor delta and gamma for price changes and theta to reevaluate time decay. Vega will be watched in case of changes in volatility.

Expiration Date and Its Impact on Greeks

The expiration date of an option has a significant impact on the Greeks, which in turn affects the option's price behavior.

• Delta: As the expiration date nears, the delta of ITM options approaches 1, while OTM options approach 0. This is because the likelihood of the option expiring ITM or OTM becomes more evident. For options with more time until expiry, the delta tends to be more moderate, reflecting greater uncertainty about where the stock will end up.
• Gamma: Gamma increases as the option approaches expiry, particularly for ATM options. This means that delta can change more rapidly, making the option more sensitive to price changes in the underlying asset. Gamma is generally lower for options with more time until expiration, indicating less sensitivity to the asset's price changes.
• Theta: As an option approaches its expiration date, the rate of time decay, represented by theta, accelerates. This is particularly important for option buyers to consider because the option's value will erode more rapidly. For options that have more time until expiration, theta tends to be lower, which indicates a slower rate of time decay.
• Vega: Options closer to expiration generally have a lower vega, making them less sensitive to changes in volatility. Conversely, options that have a longer time until expiration tend to have a higher vega, making them more sensitive to shifts in volatility.
• Rho: For options with shorter expiration dates, the impact of interest rate changes is typically less significant. However, for long-term options like LEAPS, rho is more relevant because fluctuations in interest rates can have a more prominent effect over an extended period.
  

The Bottom Line

In options trading, the expiration date is pivotal, influencing intrinsic and time value, and
thereby affecting the option's overall prices. Options come in various expiration cycles—monthly, weekly, daily, and even long-term LEAPS—to suit different trading goals and risk tolerances. The fate of an option at expiration is categorized as ATM, ITM, or OTM, each with distinct outcomes ranging from expiring as worthless to being exercised.

In addition, option Greeks like delta, gamma, theta, and vega are critical risk-assessment tools, deciphering how an option's price is expected to react to factors like stock price movements, time decay, and volatility. Understanding these concepts is essential for making informed trading decisions.