For derivative securities, the expiration date is the last day that the contract will be valid.
For future contracts, this is the day that was set for both parts to interchange assets. And, for option contracts, this is the day when the option holder will decide to either exercise the contract or let it expire worthless.
- The expiration day is the final day on which the security will be active. After that, the position will be closed.
- At expiration date, the deal will result in either a positive or a negative outcome for the counterparts.
- For options contracts, on this date, depending on the outcome, the option holder will retrieve his benefits or walk away, losing the capital invested.
- For future contracts, on this date, the counterparts can decide to renew the contract or interchange the assets as previously agreed.
Basics of Expiration Date
In the United States, regular market expiration dates are standardized for option contracts meaning that they usually expire on the Saturday following the third Friday of a month. In case that Friday falls on a holiday, the expiration date moves to the trading day before. That doesn’t apply for warrants though (free-market options) as their conditions can be adapted to the needs of their counterparts.
As options have very predictable exercise patterns, the option contract exercises are often automatized. That allows the option holder to automatically retrieve his benefits if the contract lands in an in the money scenario.
If the contract lands in an out of the money scenario, the trader may choose to close their long or short position, or roll it into a future month.
Expiration and Option Value
The further away the expiration date of the contract is, the higher the value of the option is going to be. With a bigger time-lapse, the underlying asset is more likely to have substantial price changes.
Options contracts come in two forms, calls and puts. Calls give the option buyer the opportunity, but not the obligation to buy an asset at a fixed price in the future despite the market valuation of this asset. Puts give the owner of the contract the right but not the obligation to sell an asset at a specific date in the future. This future date is better known as the expiration date.
It is for this reason that the expiration date is a significant variable for options traders. The concept of time is an essential factor of what gives the options their value. The longer the time-lapse of the traded option contract is, the higher the chances that the investor has that the asset will reach the strike price. Following this logic, the closer the option contract gets to expiration date, the less valuable the option becomes. As the trend of the stock price gets more predictable, the time value of the contract will reduce accordingly. Once the option reaches expiration date, the time value of the contract will cease to exist.
How to Handle Expiration
Futures are more different than options in the sense that they never render valueless at expiry, as there is no such thing as an out of the money future. In a future contract, the profits of an investor are directly proportional to their counterpart´s losses. Even if a future contract doesn’t result in benefits for an investor, he will be liable to his counterparty to buy or sell the asset at the accorded price.
Technically the profile of a long future investment is the same as buying an asset and waiting for the price to fall or rise, the difference being that the payment is postponed. For this reason, for traders who don’t actually want to buy or sell the asset, but just profit from a direct movement in the asset price of self, options of the preferred asset class.
Automatic exercise is the system implemented by the investment bank to protect the option holder who forgets about the expiration date or otherwise would be unable to exercise their option contracts that are in the money at expiration. Here the Option Clearing Corporation (OCC) automatically exercise the in the money option contracts and assign the underlining asset to the trader so that they may benefit from their investment.
European vs. American Options
American style options can be exercised at any time during the time lapse between the date of purchase and the liquidation date. European style options, on the other hand, can only be exercised on the specific date of liquidation when the contract expires. European and American options are not distinctive of a geographic zone, and both of them can be found in American, European, or even Asian markets.
One might assume that American options carry a higher premium since they bring more versatility to the investor. The reality is different, because of the wasting asset nature of the derivatives. The investor might have the opportunity to exercise his right earlier, but if he does, at the same time, he is dismissing the chance to do it later. So, in reality, there is no mathematically way to prove that an American option brings any more value than a European. That is still a highly controversial topic in the finance world.
How to Trade with Confidence
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