Options Expiration Explained
Unlike traditional stock investing, all options contracts have a limited lifespan and a definitive "end date" or “expiration date” at which point they become worthless or are exercised. We'll talk briefly about the 2 major types of option styles: American-Style and European-Style contracts, as well as some major expiration cycles to consider. It's also important to know that less than 10% of options are ever exercised during the month. And of those roughly 10% that are, they are typically exercised in the last week of expiration. This means you have very little risk of being assigned on a short option throughout the month.
In this video tutorial, we’re going to be talking about options expiration, just what are it and some tips, pointers, tricks, stuff like that to get you through options expiration successfully and profitably.
Options expiration: We all know, or now you know that all options have a limited useful lifespan and every option contract is defined by an expiration month. Options are finite in that they have a limited life.
They end, and just like the contract says, there’s a beginning date and an ending date. Now, this is different than traditional stock because the stock doesn't have an ending date. There’s no period when you have to turn into your stock for money.
With options, there is a defined expiration date that you either have to exercise the contract or reverse your order and sell it back to the market. The option expiration date is the date in which options become invalid, and the right to exercise is no longer there.
There are two types of options when we talk about expiration. There’s going to be American style options and then European style options. For American style options, the contract’s last trading day is the third Friday after expiration unless that day is a holiday in which case it is the previous day.
The big difference in American style option contracts is that you can exercise any of your contracts at any point up until expiration. You can turn that call contract into long shares of the underlying stock at any point up until expiration.
Now, when we talk about European style options, you can only exercise your option at the expiration date, so it’s usually the day before they expire.
For European style options, the last trading day will be the business day, generally a Thursday preceding the day on which exercise settlement value is calculated which is usually the third Friday of the month.
Again, with European style options, it’s not that you can’t get out of the trade. That's a big misconception. Some people think that with European style options, you can’t get out of the trade. That’s not the case.
But what they’re saying here is that with European style options, you can only convert the option into stock on the last day in which you can do that, so generally, a Thursday preceding the day of expiration.
As always, with our membership, we have a very helpful and useful expiration calendar in the membership area. This goes out almost four years in advance at all time. As soon as the exchanges published the new calendar, we’ll immediately have that calendar updated.
But it's really good because it helps you not only identify the holidays to count in your trading cycle but also the expiration days and also when the options stop trading. Most people always get confused; they say, “Well, I thought options expired on Saturday?”
But they don’t know that they stopped trading, and there’s no point in selling them back that Friday. That's key. You should know when exactly your options expire or when they stop trading. And then also, our calendar has the quarterly expiration as well, so very, very helpful.
There are a couple of things that are just underlying factors in options expiration that I want to go over. One is expiration cycles. This is something that you'll get into if you get into more of advanced and high-level trading.
But as you know that the year is broken down into four quarters, and within each of those quarters, there are three months. There are different ways to describe different expiration cycles in the contracts you want to trade.
In the first cycle, we have what's called the JAJO cycle and those expiration months are the first month of each quarter, January, April, July, October.
Then we have the second cycle which is the FMAN which are the expiration months, February, May, August and November which are the second months in the cycle. And then we have expiration months for the third cycle which are the third month in the cycle, and those are MJSD, March, June, September and December.
For example, I could tell someone that I want to trade the second quarter, second cycle options. Those will be the options that are located in here in May. These would be the second cycle or second quarter of the year and then also the second month in that cycle. That's how we will quickly identify those contract months.
Just some information and tidbits, some tips and tricks and useful stuff here: I bet you didn’t know that most people believe 90% of options expire worthlessly. That is widely held as true. However, this is untrue.
Normally, about 30% of options expire completely worthless in each cycle or each monthly expiration period. Only about 10% of the options are exercised before the monthly cycle, usually in the final week before expiration.
I get a lot of questions from members and from clients saying, “Well, what’s the risk that any of the strategies that I trade will be exercised?” And you can see that only about 10% of options are exercised, meaning that they’re converted from the option itself to the underlying stock.
And usually, that happens in the final week, so that's the main time that you have any risk of being exercised. But here's the key here with this, is that 60% of all options traded in the marketplace are traded out of the market before expiration.
This means that buyers sell their options back to the market and writers buy positions back at the close. A lot of traders will net out their positions by just reversing the order.
And that’s generally what happens in the marketplace. Again, these are really important key numbers that I think you should know and understand. It really will help you get over the fear factor of doing some strategies if you know some of the things that I’ve presented here.
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