A stock option gives its holder the right but not the obligation to buy or sell a share at a fixed price. This indicated price is called the exercise price. The option can be exercised at any time upon expiration, regardless of its proximity to the strike price. The relationship between the strike price of an option and the market price of the underlying stock is a major determinant of option value. What happens when your options expire? This article explores the options available to you with your options contracts as they approach their expiration date.
Key points to remember
- Call options allow contract holders to purchase assets at an agreed price at a later date.
- Put options are financial contracts that allow traders to sell assets at a specific price on a certain date.
- A call option is in-the-money when the strike price is lower than that of the underlying asset, while a put option is in-the-money when the strike price is higher than the price of the underlying asset. ‘underlying asset.
- A call option is out of the money when the strike price is higher than that of the underlying asset, while a put option is out of the money when the strike price is lower than the price. of the underlying asset.
- Traders must decide whether to sell, exercise or let their options expire as they approach the expiration date.
- A trader can sell options before expiration if they think it would be more profitable because they have time value.
What are your choices before expiration?
As mentioned above, the options are derivatives contracts that give the holder the right but not the obligation to buy or sell an asset (a bond, stock, commodity, or another financial instrument) at an agreed price at a later date. They come in two different forms:
- Call options: A call option is a financial contract that allows its holder to purchase an asset as shown above. Purchasing a call option requires the trader to pay a premium, which grants the option holder the rights he has in the contract.
- Put options: A put option gives the holder the right to sell a stock at a specified price, has no value if the underlying security is trading above the strike price at expiration.
As the expiration of an option approaches, the contract holder must decide to sell, exercise, or let it expire. Options can be in or out of the money. When an option is in the money, it can be exercised or sold. An out-of-the-money option expires worthless.
Check with your broker to find out how in-the-money options are handled at expiration. A broker such as Fidelity can automatically exercise in-the-money options on your behalf, unless instructed otherwise.
What happens after expiration?
There are two possibilities for options when they expire:
Let’s see what this means for call and put options.
The contract holder profits when the strike price of a call option is lower than the price of the underlying security. To calculate the winnings, take the price difference then subtract the amount paid for the bonus. This figure can be multiplied by the total number of shares. In this case, the option is in the money.
Exercising the call option allows you to buy shares at a price below the prevailing market price. When the option is in-the-money and nearing expiration, the holder can either sell the option to lock in value or exercise the option to buy the stock.
If the underlying security is trading below the strike price at expiration, the call option is considered out of the money. The maximum amount of money the contract holder loses is the premium. It would make little sense to exercise the call when better prices for the stock are available in the open market. So, if the option is out of the money, the option holder had better sell it before it expires.
In-the-money and out-of-the-money options depend on the position of the stock price relative to the market value of the underlying asset. When an option is in-the-money, the current asset price is higher than the strike price, while the reverse is true when out-of-the-money – the asset price is lower than the strike price. of exercise. This means he has no intrinsic value.
The reverse is true for put options. Thus, when the strike price of a put option is higher than the price of the underlying security, the trader ends up with a profit. In this case, the option is said to be in the money, which is worth it. When a put option is in the money, its strike price is higher than the market price of the whole market value.
The put option has no value and becomes worthless if the price of the underlying security is higher than the strike price. When this happens, the put option is considered out of the money. Like an out-of-the-money call option, the holder of this type of put option would be better off selling it before the expiration date.
Options no longer exist once they expire.
Timing is everything
It is important to remember that some options must be exercised at specific times. For instance:
- An American style option can be exercised at any time between purchase and expiration.
- European Options can only be exercised upon expiration.
- Bermuda Options can be exercised on specific dates as well as at expiry.
A trader may decide to sell an option before expiration if he thinks it would be more profitable. This is because the options have time valuewhich is the part of an option prime attributable to the time remaining until the expiration of the contract.
Example of options
Here is a hypothetical example to show how options work. Suppose a trader pays $2 for a $90 call option on company XYZ. Because an options contract represents 100 shares, the trader pays $200 for this investment. XYZ Company trades for $100 in the open market once the option reaches the expiration date. Currently, the call option is valued at its intrinsic value. This means that the merchant can:
- Sell the option for $10 ($100 market price – $90 strike price). The traders the profit is $800, or ($10 x 100 shares = $1,000 – $200 initial investment).
- The trader can also decide to exercise the option and hold shares of XYZ Company. To do so, they must pay $9,000 ($90 strike price x 100 shares = $9,000). In this scenario, the trader makes a paper profit $800 ($10,000 market price – $9,000 base cost – $200 for call option).
Here is another scenario. Let’s say the $90 call options return $12 each, with one week to expiration. Of this amount, $10 represents the intrinsic value ($100 market price – $90 strike price). The remaining $2 is time value, which is how the market says it thinks XYZ Company can go up another $2 in the time left before the option expires. If the trader exercises the option, the paper profit is $800 (as above). But if the trader sells the option, the profit is $1,000 (or $1,200 – $200).
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, which results in a profit for the trader holding the contract. The reverse is true for put options, which means the strike price is higher than the price of the underlying security. This means that the contract holder loses money.
Is it better to let options expire?
Traders must make decisions about their options contracts before they expire. This is because they decrease in value as they approach the expiration date. Liquidating options before they expire can help protect principal and avoid significant losses.
What is a call option?
A call option is a financial contract that gives its holder the right but not the obligation to buy an asset at a specific price on a specific date. The asset can be a stock, bond, commodity or other financial security.
What time do options expire?
Options technically expire at 11:59 on the expiration date. But the latest that public holders can exercise their options contracts is 5:30 p.m. the day before the expiration date.
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