The expiration date of an options contract is the last day at which the buyer may exercise his right on the option.
Once the options contract passes its expiration date, the option expires and becomes worthless. For example, call options give the owner of the option the right, but not the obligation, to buy an underlying security if it reaches the strike price by the expiration date.
Put options give the owner of the option the right, but not the obligation, to sell an underlying security if it reaches the strike price by the expiration date.
The expiration date is a necessary piece of an options contract that must be understood to be a successful options trader. This article will further explain the basics of what the expiration date of an options contract is.
The expiration date affects the price of an options contract. The farther away the expiration date is from the time of purchasing the option, then the more time the holder has for the option to expire “in-the-money” and potentially make a profit. The more time an option has until expiration, then the higher the price the option should be.
Generally, the expiration date for listed stock options in the United States is the third Friday of the month that the contract expires. Index options are also the third Friday of the expiration month.
On the expiration date, some options are automatically exercised by the clearing firm if the option is “in-the-money.” If an option buyer does not want his options automatically exercised on the expiration date, then he must close out the option himself.
Let’s look at an example that ties these concepts relating to the expiration date together.
Assume on Jan. 1, an investor buys one call option for the Sony Corporation (NYSE: SNE) with a strike price of $50 that has an April expiration date. The option cost was $3 per share. One option contract equals 100 shares of stock. This call option contract gives the buyer the right to buy 100 shares of SNE at a price of $50 any time before the April expiration date, regardless of what the market price is of SNE.
Suppose the market price of SNE rose to $55 on Feb. 1. The buyer can exercise his option because it was “in-the-money.” This means that the market price of SNE was above the strike price on the options contract.
The buyer can buy 100 shares of SNE at $50 because he has the right to do so. Then, the option buyer can sell those shares at the market price of $55. This gives the buyer a profit of $5 per share. However, the buyer did pay a premium for the option of $3 per share. In total, the buyer keeps a profit of $2 per share.
What if the investor bought a call option with a February expiration date rather than an April date? The premium the buyer would pay for a February call option would be cheaper than the April call option. Suppose the premium for the February call option is $1 per share. The buyer then would have earned a profit of $4 per share rather than $2 per share. This is because the more time an option has until expiring, the more likely it will expire “in-the-money.” Thus, the option receives a heightened premium.
That is why the April call option is more expensive than the February call option. In both cases, the buyer makes a profit, but the more profitable decision between the two options is the February calls, which would produce a greater profit than the April option.
Investors should think strategically about an expiration date on an option. The length of time before an option expires when it is purchased affects its potential profitability for the holder.