Options die. The expiration date is a fundamental property of all options. They trade on exchanges that enforce standard expiration dates. When an option expires, the contract terminates and traders receive the final value, if any, either in cash or in the underlying asset. Many options expire as worthless.
The cost of an option is its “premium.” The option seller collects a premium; an option buyer pays it. Call options give the buyer the right to purchase a set amount of an underlying asset for a specified price -- the strike price -- on or before the expiration date. A put option is similar, except that the buyer has the right to sell the underlying asset at the strike price. Call option prices move in the same direction as that of the underlying asset. Put option prices move in the opposite direction. You exercise an option by buying or selling the underlying asset.
Every option has an expiration month. An option’s trading symbol is in part a code for the expiration month. In the United States, stock options nearest to expiration typically have expiration dates of one to three months in the future. Options with more distant expiration dates have one expiration month per quarter. Long-lived options may have lifetimes of up to three years. Other types of options may have different expiration calendars. Standard stock options normally expire on the third Saturday of the expiration month, but they end trading on the day before. This one-day interval gives absent-minded option owners a chance to sell valuable options even after trading has ended, Certain specialists called market makers usually will purchase your forgotten option on expiration Saturday.
The Waste of Options
Option prices are derived from two sources. The option’s intrinsic value is the profit you earn by exercising the option at the strike price rather than at the current market price of the underlying asset. The other price source is time, referred to as “theta.” Theta is really the price of hope -- hope that the option will become more valuable before expiration. Until that hope is extinguished at expiration, an option can have a positive value even if it lacks any intrinsic value. An option’s time value wastes away at an increasing pace as expiration approaches. At expiration, the time value is zero.
At the end of trading on the third Friday of the expiration month, your option may have value. Traders may leave standing instructions with their brokers to sell valuable -- or in-the-money -- options at Friday's market close. By selling an option, you make the same profit that you would make by exercising it and immediately selling the underlying asset. If you don’t tell your broker to sell your option before expiration, the broker may execute it on your behalf. Upon exercise, the exchange will compel the call seller to deliver the underlying asset to your account and debit payment from your account. Out-of-the-money options expire quietly, with no value to the buyer except as a capital loss that might lower taxes.
Based in Greenville SC, Eric Bank has been writing business-related articles since 1985. He holds an M.B.A. from New York University and an M.S. in finance from DePaul University. You can see samples of his work at ericbank.com.