When you trade options, you possess the right to buy or sell an underlying security with certain terms.
David Jaffee of BestStockStrategy.com has taught more than 1,500 students how to trade options, including choosing the best expiration dates.
Options are contracts that expire at a set date and time.
Unlike stocks, options cannot exist forever and a decision must be made prior to the expiration date.
While the buyer of the option contract has the right to buy or sell the underlying stock, they are not obligated to do so.
There are three potential outcomes for options, including exercising the option before the expiration date, an option that expires in the money, or an option that expires out of the money.
Keep reading to learn what happens when options expire.
An updated version of this post has been posted about what happens when options expire here: https://beststockstrategy.com/options-expire/
What does expiration mean?
If you want to become successful at trading options, you have to learn the fundamentals.
A put option gives the owner of the contract the right to sell a specific amount of an underlying security within a predetermined time frame at a specific price.
A call option gives the contract owner the right to buy an underlying stock at a specific price within a predetermined time frame.
Option sellers write an option, and they may be obligated to buy or sell shares of an underlying stock at the strike price before the option expires.
While stocks can exist in perpetuity, all options contracts have an expiration date.
The expiration date represents the last day that the options contract is valid.
After the expiration date, the option contract ceases to exist.
In the US, weekly options expire on Friday and monthly options expire on the third Friday of the month (except for indices, which have multiple expirations during the week).
Options lose value as the expiration date approaches, so it is very important for traders to pay attention to expiration dates.
If the option is not exercised by the expiration date, it will expire either in the money or out of the money.
What happens when options expire in the money?
When an option expires in the money, a trade is typically executed in the underlying stock.
For call options, an option is in the money if the price of the underlying stock is higher than the strike price of the option.
For put options, an option is in the money if the price of the underlying stock is less than the strike price of the option.
Just because an option expires in the money does not mean the trader makes a profit (although it's likely that if an option expires in the money that the option buyer will realize a profit).
Expiring in the money simply means that the option is assigned and the amount of stock specified in the contract is bought or sold.
Problems occur when an option position approaches expiration and the trader does not have the necessary capital in their account to purchase or sell the specified amount of stock.
This can lead to a margin call or a forced liquidation of the position.
What happens when options expire out of the money?
When an option expires out of the money, nothing further happens.
The option expires worthless and shares are not assigned.
An option that expires out of the money does not have any intrinsic value and it will disappear from a trader’s account.
For call options, an option is out of the money if the strike price is higher than the underlying security’s current price.
For put options, an option is out of the money if the strike price is less than the underlying security’s current price.
While out of the money options oftentimes give buyers more leverage and capital efficiency, they also have an increased risk of expiring worthless.
Can you exercise an option before it expires?
A common misconception with options contracts is that they most often expire out of the money.
It may come as a surprise, then, that the most frequent outcome actually involves a trader closing the position before the option’s expiration date.
Traders buy and sell options with the goal of making money, which requires the best and safest options trading strategy.
When a trade works in your favor, you can close the position in the marketplace prior to expiration and cash in.
On the other hand, you can also close a trade that is working against you and cut your losses early.
Make Money on Up to 98%+ of Your Trades
Whether an option expires in the money or out of the money, traders are still taking a gamble.
Instead of acting like a gambler and taking on greater risk, you can position yourself like the casino.
By selling option premium, you can win almost 100% of your trades.
Learn the fundamentals of options trading, including what happens when an option expires, from David Jaffee of BestStockStrategy.com.
With the best options trading strategy, you can minimize risk and maximize your potential for profit.
Frequently Asked Questions (FAQs)
What happens when options expire?
Each option has an expiration date, which is when the contract expires and ceases to exist, and a strike price. If the contract is exercised, the underlying security is bought and sold at the option's strike price. Moneyness. Options can either be in the money (ITM), at the money (ATM), or out of the money (OTM).
What happens if you let an option expire?
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.
What happens when options expire in the money?
When a call option expires in the money, it means the strike price is lower than that of the underlying security, resulting in a profit for the trader who holds the contract. The opposite is true for put options, which means the strike price is higher than the price for the underlying security.
Should I let my option expire?
If your short put position is in the money and you believe that the underlying will appreciate in value, then taking ownership is worthwhile.
If your short put it out of the money, then it's usually best to buy it back for less than 10 cents.
If your short call is in the money, and you believe that the underlying will fall, then you can take assignment.
If your short call is out of the money, then it's usually best to buy it back for less than 10 cents.