Options Expiration: Definitions, a Checklist, & Risks

In an earlier era of options trading—two or three decades ago—for market makers in the options trading pits in Chicago and other financial centers, there was one day a month in which attendance was virtually mandatory: options expiration day. Volume was usually heavy, and the potential for volatility was ever-present. In short, trading options on expiration day was seen as a time of opportunity and risk.

Nowadays, however, with midweek and weekly options adding to the standard monthly and quarterly dates, options expiration happens every day of the week.

If you’re new to options, and you don’t quite understand all the terminology and logistics, expiration can also be a time of peril. Here are a few things you need to know to avoid potential pitfalls and better understand the ins and outs of expiration day. 

Some basic lingo

Option holder. The buyer (“owner”) of an American-style option has the right, but not the obligation, to exercise the option on or before expiration. A call option gives the owner the right to buy the underlying security; a put option gives the owner the right to sell the underlying security.

Multiplier. When an option holder buys a put or call, they pay a premium, and to arrive at the total cost of an options contract, the premium is typically multiplied by 100 (exceptions may exist with some non-standard options contracts). For example, if an option is trading for $1.40, the price of one contract, excluding fees, is $140, or $1.40 x 100 (multiplier) = $140.

Expiration. Each option has an expiration date, which is when the contract expires and ceases to exist.

Strike price. Each option also has a strike price, and if the contract is exercised, the underlying security is bought and sold at the strike price of the option.

Moneyness. Options can either be in the money (ITM), at the money (ATM), or out of the money (OTM). An ATM option has a strike price at or near the price of the underlying asset. A call option is ITM if the stock price is above the strike price (opposite for puts) and OTM if the stock price is below the strike price (reverse for puts).

Option writer. When you sell (“write”) an American-style option (call or put), you may be assigned if the option is ITM on or before expiration day (and even OTM in special cases described below). The option seller has no control over assignment and no certainty as to when it could happen. Assignment on a short call means delivering shares out of the account and assignment on a short put means buying shares into the account.

Options intrinsic value. This is the difference between a strike and the underlying’s current price. Suppose a stock is trading for $51 and a 50-strike call option is worth $1.40. The intrinsic value would be $1, the amount by which it’s ITM. The extra $0.40 is known as extrinsic value, or time value. OTM options consist only of extrinsic value.

What are the terms? American or European? Cash or physical delivery?

American-style options can be exercised any time before the options expiration date, whereas European-style options can only be exercised at expiration. Standard U.S. equity options (options on single-name stocks) are American-style. Most options on stock indexes, such as the Nasdaq-100® (NDX), S&P 500® (SPX), and Russell 2000® (RUT), are European-style.

Also, standard equity options are not cash-settled—actual shares are transferred in an exercise/assignment. Options on broad-based indexes, however, are cash-settled in an amount equal to the difference between the settlement price of the index and the strike price of the option times the contract multiplier.

Settlement and triple witching

Each quarter, on the third Friday in March, June, September, and December, contracts for stock index futures, stock index options, and stock options all expire on the same day. This so-called “triple witching” may lead to greater trading activity and increased volatility.

Most index options, such as the SPX, NDX, and RUT, settle Friday morning but stop trading on Thursday afternoon (before the third Friday of the month). But the settlement price isn’t computed until Friday morning. The monthly option AM settlement value isn’t based on the opening price of the index, but rather on the price determined by the opening trade price in each stock that comprises the index. This is known as “the print.”

What if a market-moving event happens between Thursday night and Friday morning? Print risk is the overnight risk in AM-settled options.

PM-settled options trade until the end of the day and settle based on the closing value of the underlying security or settlement value of the index. On the last trading day, trading in an expiring PM-settled option closes at 3 p.m. CT for options on single-name equities. Options on equity indexes (cash-settled) expire at 3:15 p.m. CT.

Did you know?

Expiring options will be automatically exercised if they’re ITM by $0.01 or more as of the 3 p.m. CT price (for equity options) and 3:15 p.m. CT price (for options on indexes). In general, the option holder has until 4:30 p.m. CT on expiration day to exercise the contract. These times are set by the Options Clearing Corporation (OCC), the central clearing house for the options market. But some brokerage firms might have an earlier cutoff than the OCC threshold.

If your long option is ITM at expiration but your account doesn’t have enough money to support the resulting long or short stock position, your broker may, at its discretion, choose not to exercise the option. This is known as DNE (do not exercise), and any gain you may have realized by exercising the option will be wiped out. DNEs can be submitted by any option holder and instruct the broker not to auto-exercise ITM options at expiration. A broker may also, at its discretion, close out (sell) the position without prior notice to you. Meanwhile, OTM options expire worthless.

Expiration checklist: Manage and monitor your expiration risk

Everybody loves a long weekend, but if you’ve ever taken an unwanted position into the weekend due to an options expiration mishap, that time between Friday expiration and the Monday open can feel like a painful, gut-wrenching eternity.

Now that you’ve been introduced to the lingo and logistics, here’s a list of things to know, check, and perhaps double-check as you go into expiration.

Do your research.Are there news alerts like ex-dividend dates, earnings, or other announcements expected on a company in which you hold expiring options?

Check your specs. Do your options settle American- or European-style? Is settlement in the morning or afternoon? What are the trading hours? Does the underlying trade outside of regular market hours? For example, options that are ITM as of the close are typically automatically exercised, and OTM options aren’t. However, if the price of the underlying changes after the close, you might have a short option go from OTM to ITM. The option holder may choose to exercise, leaving you with an unwanted (or at least unexpected) position. However, there is also no guarantee that an ITM short option you hold will be assigned.

Liquidate (or have enough cash on hand). To avoid any margin calls or unwanted overnight or weekend exposure, make sure you plan ahead for any positions you might acquire on expiration. For example, to exercise a long equity call option, you need to have enough cash in your account to pay for the shares. Alternatively, if your account is approved for margin trading, you need to hold cash or securities to satisfy the “Reg T” margin requirement. If you’re unsure, or if you don’t want the position, liquidate the option before market close. Just remember, there’s no guarantee of a liquid market.

Leave yourself some time. Unlike some video games, in options trading, it’s not always a good thing to be the last person standing. As you get closer to 3 p.m. CT on expiration day, liquidity can often dry up and bid/ask spreads may widen. So, if you’re considering liquidating, or even rolling to another expiration date, sooner may be better.

Risks and rewards

Here’s one final item for your expiration checklist: Know and understand your risk. The risk profile below shows an example of a long vertical call spread, which is created by being long the 90-strike call and short the 95-strike call. Note that if, at expiration, the price of the underlying is below the 90 strike, both options will likely expire worthless.

On the other hand, if the underlying is above $95 at expiration, then the spread will likely be closed without a resulting position in the underlying, as the $90-strike call is exercised, and the $95 strike is assigned (the stock is called at $90, then immediately sold at $95). However, there is no guarantee that the ITM 95-strike call will be assigned (if the holder submits a DNE request, for example), which could result in an unexpected long stock position at $90 per share.

But what about the area in between the strikes? And, in particular, what about those points of uncertainty right around the 90 and 95 strikes? Will you have a position, or won’t you?

If the 90-strike call is ITM and the 95-strike call is OTM at expiration, the lower strike call will be subject to automatic exercise and the 95-strike call will likely expire worthless. Therefore, you’d buy the shares for $90 unless you close the position by selling the spread prior to expiration (or submit a DNE for the ITM call). If the underlying is at the points of uncertainty around the 90 and 95 strikes, and you don’t want to exercise the contract or get assigned, then you’ll likely want to try to close the spread before expiration or submit a DNE with your broker.

Now that you’ve been introduced to the language and logistics of expiration, you may be able to approach expiration with a greater understanding of the risks and how you might manage them. You might want to keep this checklist handy just in case.