What Happens on Option Expiration Date?
Options are versatile investment tools, and investors use the options markets for a variety of reasons. As a result, there are many strategies for holding options, some of which may involve exiting option trades before their expiration or maintaining an option all the way to the expiration date. Either way, learning what happens on an option's expiration date is one of the first things a trader should do before entering the options markets.
Expiration
Stock options expire on the Saturday after the third Friday of the month, with Friday being the last trading day for the option. Futures options expire at various dates, depending on the futures market in question. The expiration date is significant for both option buyers and sellers, and investors face different outcomes depending on whether an option is "in the money" or "out of the money."
In-the-Money Options
In-the-money options are those with have intrinsic value at expiration. Specifically, these are calls with a strike price below the market price and puts with a strike price above the market price. At expiration, the buyer exercises in-the-money calls, leaving the option holder with a long position in the underlying market. Likewise, the buyer exercises in-the-money puts, establishing a short position in the underlying market. In both cases, the option seller takes an opposite market position relative to the option holder.
Out-of-the-Money Options
Out-of-the-money options are those with no intrinsic value at expiration. Specifically, these are calls with strike prices above the market price and puts with strike prices below the market price. At expiration, these options simply expire worthless. Buyers lose the premiums they paid for these options, while sellers retain the premiums they received from buyers and no longer have to worry about the possibility of exercise.
Time Value
Options have a "time value" reflecting their potential to expire in the money, based on the amount of time left until expiration. An option's time value decreases exponentially as expiration nears and reaches zero at expiration.
American vs. European
The two main varieties of options with regard to exercise rules are American options and European options. A buyer may exercise an American option at any time, meaning that if an option goes in the money, the option holder may choose to exercise before expiration. In contrast, a buyer may exercise a European option only at expiration. Therefore, European options must be in the money at expiration if the holder wishes to exercise them.
Tags: market price, with strike, option holder, above market, above market price, below market, below market price