Options Expiration Explained



All option contracts are time limited, there’s no such thing as an open ended option. Once the option expires the contract becomes invalid and you can no longer exercise the option at the strike price.

Upon expiry you can either exercise the option and buy the shares at the strike price or simply let the option expire. You’re under no obligation to buy the shares.

If you choose to let the option expire, you’ll only have to cover the cost of the options contract itself, there are no other penalties or fees to pay.

When do Options Expire?

For stock options listed on the Chicago Board Options Exchange (CBOE), the expiration date falls on the third Friday of the month (except when that Friday is a bank holiday, in which case it’ll be brought forward to the preceding Thursday).

The Expiration Cycle

At any given time, a minimum of four different expiration months are available for every given option. When stock options first became available in 1973, the only expiration months available were the months attributed to the expiration cycle assigned to that particular stock.

As options trading became more popular, this system had to be modified; since traders wanted to use short term options to hedge open positions, they found that the current trading month wasn’t always available.

Under the new system, there would still be four option expiration months listed at any given time but two are reserved to represent the current month and the following month. The remaining two months would remain from the original quarterly cycle. The current and following months are referred to as serial months.

Stock options belong to one of three expiration cycles. The first cycle, the JAJO cycle, expires on the third Friday of the first month of each quarter – January, April, July, and October. The second cycle, the FMAN cycle, expires on the third Friday of February, May, August and November. The expiry dates for the final cycle, the MJSD are March, June, September and December.

Determining the Expiration Cycle

Since there’s no set pattern as to which expiration cycle a particular option is assigned to, the only way to find out is to deduce from the expiration months that are currently available for trading.

To do that, look at the third available expiration month to see which cycle it belongs to. If the third expiration month happens to be September, then use the fourth expiration month to confirm that the stock is assigned to the March, June, September, December (MJSD) expiration cycle.

Conclusion

As you can see the expiration date is more complicated than it may seem, but once you’ve carried out a few trades you’ll soon get the hang of it. In any case you’re very unlikely to let your option expire, since most options are sold back to the market long before the expiry date.

The main reason you’re likely to keep an option open until expiry is if you’re using options to build your portfolio. This is a common strategy which enables you to keep your capital more liquid and buy shares at the most convenient times i.e when the price is low. Rather than being dictated by your current cash flow.

If you’re new to options and want to try them out for yourself, I recommend you sign up for a virtual trading account at optionsXpress. They have a fully featured virtual trading account, which lets you carry out virtual trades in real time and in real market conditions.

They also offer some of the best options training around. So get your options trading career off to a great start by learning how to trade the right way by signing up for a virtual trading account at optionsXpress today.




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