The expiration date of a stock option is the day in which the contract is no longer valid. Once this date has passed, the contract no longer exists and becomes worthless. This date for all options traded in the U.S. are all set to expire on the third Friday during the expiration month. If this day falls on a holiday, then the third Thursday of the month is used.
Why are Expiration Dates Important?
Option expiration dates are important for a number of reasons. The most important thing to remember for investors who own options is that once the date has passed, the investment becomes worthless. The investor must either exercise the contract to buy (call) or sell (put) the stock at the strike price. If the option is not exercised, then the investor can place a sell to close order and collect whatever option premium remains.
The expiration date of an option also plays a major role in determining the premium of the contract. A perfect way to see the impacts that this date has on the premium is to look at out of the money options. Contracts that have a closer expiration date will be worth less compared to those further out. Take a look at a call or put option for the same stock with the same strike price. You will notice how out of the money contracts that are set to expire soon are worth much less than those that have more time till expiration.
Multiple Option Trading Strategies
There are numerous options trading strategies that use the expiration date in different ways. For example, investors who sell covered calls look for contracts that are set to expire within a month or two. This strategy is used to lower the risk of the contract being exercised so the investor can keep their stock and pocket the premium paid.
Options investors who sell deep in the money calls is another example of when traders use the expiration date in their analysis. This strategy uses time as a big part of the potential for profits. These investors want the calls they own to have plenty of time to increase in value so they can maximize their profits.
There are numerous other strategies that make use of the expiration date of an option.
In order to be a successful options trader, investors must factor in the expiration date in their analysis. We know that it plays a major role in calculating the premium of every option contract. It also lets us know when the contract is set to expire so we can make decisions on when to cut our losses or take profits.