Selling options is a good way to generate consistent income in the stock market. By selling options, you turn yourself into an insurance company and collect premium.
Similar to an insurance policy, the option that you sell has an expiration date. But what happens when options expire?
If an option expires worthless, then its value falls to $0 and the option will be removed from your account. If an option expires with intrinsic value, or "in the money", then the person who sold the put option will buy 100 shares of the underlying stock at the strike price for every option that they sold.
If the option seller sold a call option that expires in the money, then the option seller will sell 100 shares of the underlying stock at the strike price for every option that they sold.
For example, let's say that you sold 5 put contracts of XYZ with a strike price of $120. On expiration day, XYZ is trading at $115.
As a result, you'll purchase 500 shares of XYZ at $120 / share.
Remember:
Unlike a stock, each option contract has a set expiration date. The expiration date significantly impacts the value of the option contract because it limits the time you can buy, sell, or exercise the option contract. Once an option contract expires, it will stop trading and either be exercised or expire worthless. Source
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Risks of Options Expiring
One of the biggest risks is that the buying power requirements for options and stocks is not the same.
When selling options, you're usually provided with 2.5x the amount of leverage when using Regulation T (and ~5x the leverage when using Portfolio Margin).
One problem that many traders run into is correlation risk - where numerous option positions will become challenged and in the money, and therefore the trader will run out of buying power and not be able to take assignment of the shares.
Running out of buying power is the biggest risk associated with option assignment.
What Happens When Options Expire (Conclusion)
As an option approaches expiry, the contract holder must decide whether to close out, or sell, the position, exercise, or let it expire.
Options can be in or out of the money and only an ITM option can be exercised.
When an option expires, the associated contract either is no longer valid or it will be converted to short or long stock shares.
Having an option expire is NOT a bad thing, it's just like an insurance company selling an insurance policy that lapses over time.
Frequently Asked Questions (FAQs)
What happens when call options expire in the money?
If a call option expires in the money, the option seller will be forced to sell 100 shares for every contract they sold in the underlying stock, at the strike price.
If a put option expires in the money, the option seller will be forced to buy 100 shares for every contract they sold in the underlying stock, at the strike price.
When do options expire?
Every option has a set expiration date (which is usually a Friday), although SPX, SPY and other options have daily expirations.
What happens when a put option expires?
If a put option expires in the money, the option seller will be forced to buy 100 shares for every contract they sold, in the underlying stock at the strike price.
If the option expires out of the money, then the option will disappear from your account and the seller of the option will keep all of the premium collected.
How Can I Learn More About Options Trading?
When do expired options disappear?
Expired options usually disappear from your trading account the next day, or prior to the opening of the next trading day.
What happens when options expire out of the money?
Expired options usually disappear from your trading account the next day, or prior to the opening of the next trading day.
What happens if you don't sell an option before expiration?
An option contract has an expiration date. An option will lose value as it gets closer to expiration, this is called theta decay.
An option contract stops trading at expiration, and it will either be exercised (if it's in-the-money, and has intrinsic value), or it will expire worthless if it's out-of-the-money and has no intrinsic value.