Have you been wondering about what happens when a call options expires?
Well, the answer to it depends on who you are (buyer or seller) and where the underlying (stock/index) is at expiration.
here’s a short table that can help:
what does it mean for an option to expire?
the contract no longer exists after the expiration date. All derivatives contract come with an preset end date. Whatever bet you placed is now over and its time to decide if you won or lost.
what happens near and after expiration?
If you hold a call stock option that is making profit – you might be asked to bring in more money in order to be ready to take delivery of the stock. Remember, it cost you very little premium to place the bet in the first place. Now, the full value of the contract comes into play.
If you hold an Index option that is cash settled, then it is up to you to either book profit or to wait it out till expiration. You won’t be asked to bring in any extra cash.
after expiration – any action after expiration is triggered only if the underlying stock/index is above your strike price (refer to above table). Else, the contract is deemed worthless and no more action is taken.
if you held a short Index option that is in the money, you will be expected to bring in further margin. The increased margin is to prepare for any eventuality of loss.
what is exchanged between buyer and seller?
If you hold Index option in profit, you get cash [diff. between settlement price and strike price].
Stock option will get you the stocks delivered.
In case of Call Index option, then the difference between Strike and Index is debited from your account – cash.
And if the call option you sold was that of a stock, you have to deliver the stock.
what steps can be taken before expiration?
[buyer in profit]
Since you are in profit, you can choose to sell the option and book profits OR exercise and take delivery of stock. Remember, you are running against TIME. Premium of an option tends to drop significantly as it approaches expiration.
[buyer in loss]
Choose to book loss or wait hoping that the stock/index would make a move in the very little time remaining. Again, its worth repeating about running against TIME. Premium of an option tends to drop significantly as it approaches expiration.
[seller in profit]
It would be wise to book profit. it is not worth waiting to collect the last few pennies left in the option premium as it poses Gamma risk. After the successful trade, its time to rinse and repeat !
[seller in loss]
Unlike option buyer who has suffered a loss – its not all over for an option seller. He/She can still salvage the trade to recover the loss. You just have to put on your creative hat and think of all possible trade adjustments you can make to recover your loss.
one of the most important tool an option seller has is TIME.
should you continue to keep buying option to make money?
Data does not seem to support this statement. Buyer of an option is akin to someone buying a lottery – with very little odds of winning. You could gamble a bit and make a windfall profit on one freak trade. Eventually to lose it all on other trades. In the end, the house always wins.
can option selling guarantee steady flow of money?
Selling options is not an easy game. Many Option Sellers consider selling as a “set-it-and-forget-it ” strategy. Expecting the trade to drive itself on autopilot .
On the contrary, it is very important to stay vigilant when you are a seller of an option. It would be wise to consider worst case scenarios.
if you are interested in learning further on how to be the “house that always wins”, i’d direct you to amazon’s section here.
It takes skill and ability to stay calm on turbulent times.
Based on my experience, i believe an option seller armed with the right mindset can make it into full time income hustle. what do you think? what has been your experience?
if you liked what you read and know someone who might benefit – share.