In the world of financial markets, trading options has become an increasingly popular way for investors and traders to manage risk and generate potential profits. Among the essential concepts in options trading is the understanding of options expiry. Options expiry, also known as expiration, is a crucial event that marks the end of an option contract’s validity. This blog will provide a detailed explanation of options expiry, its significance, and how it affects options trading.
What are Options Trading?
Before we delve into options expiry, let’s briefly review what options are. Options are financial derivatives that provide the holder with the right, but not the obligation, to buy (call option) or sell (put option) an underlying asset at a predetermined price, known as the strike price, on or before a specified date, which is the options expiry date. The underlying asset can be stocks, indices like Nifty or Bank Nifty, commodities, or other financial instruments.
Understanding Options Expiry
Options contracts have a limited lifespan, unlike stocks that can be held indefinitely. The options expiry date sets the deadline for executing or expiring the contract. Once the options expiry date passes, the contract becomes null and void, and the rights granted to the option holder cease to exist.
Options have various expiration cycles, and the choice of the cycle depends on the exchange where the options are traded. The three main cycles are:
Monthly Expiry (Serial Options): These options expire on the last Thursday of the month. Most actively traded options fall into this category, providing traders with frequent opportunities to enter and exit positions.
Weekly Expiry: These options have a shorter lifespan and expire on each Thursday which is not part of the monthly expiry cycle. Weekly expiries are beneficial for traders seeking to capitalize on short-term price movements.
Bank Nifty Weekly Expiry: Also, Fin Nifty index derivatives have their expiry on Tuesdays. However, if a bank holiday or a trading market closure aligns with the scheduled expiry date, the contracts will expire one day before the original expiry day.
Expiration Day and Time
The options expiry date in the stock market is generally on the last Thursday of the month for monthly options and every Thursday for weekly options. However, if the last Thursday is a trading holiday, the expiry is advanced to the previous trading day. The exact time of expiry is at the end of the trading session on the expiry date, typically at 3:30 PM for NSE (National Stock Exchange) and BSE (Bombay Stock Exchange).
In-the-Money (ITM), At-the-Money (ATM), and Out-of-the-Money (OTM)
Options traders often use the terms “in-the-money,” “at-the-money,” and “out-of-the-money” to describe the relationship between the underlying asset’s price and the option’s strike price:
In-the-Money (ITM): A call option is in-the-money when the underlying asset’s current market price is higher than the option’s strike price. Conversely, a put option is in-the-money when the underlying asset’s current market price is lower than the option’s strike price. ITM options generally have intrinsic value.
At-the-Money (ATM): An option is at-the-money when the underlying asset’s current market price is approximately equal to the option’s strike price. ATM options typically have no intrinsic value but may still have time value.
Out-of-the-Money (OTM): A call option is out-of-the-money when the underlying asset’s current market price is lower than the option’s strike price. A put option is out-of-the-money when the underlying asset’s current market price is higher than the option’s strike price. OTM options have no intrinsic value and consist solely of time value.
Importance of Managing Options Positions Before Expiry
As options approach their expiration date, they become increasingly sensitive to changes in the underlying asset’s price. Traders should be aware of the risks associated with holding options positions until expiration, as it could lead to significant losses or missed opportunities. Here are some essential points to consider:
Early Exercise: American-style options can be exercised by the option holder at any time before expiration. It is crucial to monitor ITM options carefully as they might be exercised early, potentially leading to unexpected positions in the underlying asset.
Rolling Positions: To avoid expiration risk, traders can roll their options positions forward by closing the current position and opening a new one with a later expiration date. This strategy allows traders to maintain their market exposure and potentially reduce the impact of time decay.
Closing Positions: If an options position is no longer favorable or aligns with the trader’s strategy, it’s often best to close the position before expiration, realizing any remaining value in the option.
Understanding options expiry is crucial for anyone involved in options trading in the stock market. The expiration date marks the end of an option contract’s validity, and traders must consider various factors like expiration cycles, in-the-money, at-the-money, and out-of-the-money status, and time value decay (Theta) to make informed decisions. By comprehending the nuances of options expiry, traders can develop effective trading strategies, manage risk efficiently, and potentially capitalize on profitable opportunities. However, options trading involves risk, and it is advisable to conduct thorough research and seek advice from financial experts before engaging in options trading.