OPTIONS EXPIRATION EXPLAINED: WHAT HAPPENS AT EXPIRY

Understanding Options Expiration

Options expiration is a critical event in options trading that marks the final point at which an options contract can be exercised. Every options contract has a predefined expiry date, after which it becomes void and ceases to have any value. This date is crucial because it determines the contract's lifespan and affects its time value—a key component in options pricing.

An option gives the holder the right, but not the obligation, to buy (for calls) or sell (for puts) the underlying asset at a specified strike price on or before the expiration date. If the option expires in the money (ITM), it may be exercised or automatically assigned, results varying depending on the type of option and the brokerage account specifics. Conversely, if the option expires out of the money (OTM), it usually becomes worthless and is removed from the trader’s account.

Weekly, monthly, and quarterly expirations are common in options markets. Standard U.S.-listed equity options typically expire on the third Friday of the expiration month, unless that day is a public holiday—in which case, expiration occurs on the previous trading day.

Time Decay and Expiration

Time decay (or theta) accelerates as the option’s expiration date approaches. This loss of extrinsic value can quickly erode a position’s worth, particularly for options that are at or out of the money. Therefore, understanding how time decay interacts with expiration helps traders manage position risk effectively.

Key Expiry Terms to Understand

• Expiration Date: The last date the option is valid.
• Last Trading Day: The final day the option can be bought or sold—often the same as the expiration date, but may differ for some products.
• Settlement: The process of exercising or closing the contract, either physically or in cash.
• Automatic Exercise: Brokers and clearinghouses may automatically exercise options that are ITM by a certain amount, often $0.01 for U.S. equity options.

Exercise and Assignment

When an option is exercised, the holder enacts the right to buy or sell the underlying asset at the strike price. Conversely, assignment occurs when the other side of the trade—usually the option writer—must fulfil the obligations of the contract. This could result in long or short positions in the underlying security, depending on the contract type and position held.

Being aware of these discrete mechanics ensures better trade planning and risk mitigation.

Expiry Day: What Traders Need to Know

As the expiration date arrives, all open options positions face definitive outcomes. Whether the contracts are closed, exercised, assigned, or expire worthless depends on their moneyness and trader preference. Understanding these outcomes is vital for managing exposures appropriately.

1. In-the-Money (ITM) Options

If an option is ITM at expiry—i.e., a call with a strike price below the underlying’s market value, or a put with a strike above—the contract will likely be exercised automatically. Most brokerages and clearinghouses exercise options automatically if they are at least $0.01 ITM, unless specified otherwise by the account holder.

For instance, if you hold a call option with a $100 strike and the stock closes at $105 on expiry day, you will likely be assigned 100 shares at $100 per contract by default. Conversely, a short options position might require you to either deliver or purchase those shares, depending on the exact terms and the type of option (call vs. put).

2. Out-the-Money (OTM) Options

OTM options expire worthless. Calls with strike prices above the current market value, or puts with strike prices below it, have no intrinsic value. They are simply removed from your portfolio after market close on expiry day unless they are manually closed earlier for salvage value or loss harvesting.

3. At-the-Money (ATM) Options

ATM options expire with little to no value and may or may not be exercised depending on brokerage policies. Some traders prefer to close such contracts manually to avoid potential uncertainties around settlement or slippage.

Assignment Risk

Option writers (sellers) must be especially cautious. Assignment can occur at any point in American-style options, even before expiry. However, the likelihood increases significantly near and at expiration, when most options reach maximum delta sensitivity and time value is exhausted.

To avoid surprise assignments, it's prudent for option sellers to monitor positions closely and often consider early rollovers or closes prior to expiry if contracts approach ITM status.

Post-Expiry Implications

Once contracts expire, they are no longer listed on trading terminals. Any positions tied to assigned options become regular equity or futures positions. Realised profit/loss is recorded, and margin implications may arise based on the settlement type.

Clearing firms usually provide final confirmation of exercised or assigned status by the next business day (T+1), and those affects will be seen on traders’ account balances and position statements.

Managing Expiry: Strategy and Settlement Plans

Effective expiry management contributes significantly to long-term trading performance. Whether through manual closure of positions or preparing for potential assignments, understanding settlement processes and incorporating appropriate strategies is key.

Manual Close Before Expiry

One of the most proactive strategies in options management is to close open contracts before expiration. This approach enables traders to realise gains or losses and avoid unexpected assignments or fees. It also provides the chance to re-deploy capital more efficiently.

For instance, if an option is ITM and profitable, selling it before expiry locks in gains without exposure to assignment risk. Similarly, OTM positions with minimal premium left can be closed to avoid regulatory issues in certain margin accounts.

Automatic Exercise Rules

Clearing firms have set policies for automatic exercise. Contracts ITM by a minimal threshold—often $0.01—are exercised unless the client opts out. Conversely, contracts OTM are abandoned. Traders should understand their brokerage’s automatic exercise rules and provide explicit instructions when needed, especially for contracts near the strike price.

Cash vs. Physical Settlement

Options settle in two main ways:

• Physical settlement: Applicable to equity options, where shares are transferred upon assignment/exercise.
• Cash settlement: Common with index and futures options, where the net value difference between strike and spot price is paid out in cash.

Cash-settled options eliminate the requirement to transact in the underlying asset, making them suitable for institutional strategies. However, physical settlement requires traders to monitor account margin levels and minimum capital requirements post-assignment.

Common Expiry Trading Strategies

• Rolling: Closing expiring contracts and opening new ones with later dates.
• Pin risk hedging: Actively managing ATM contracts to avoid unpredictable assignment.
• Spread unwinds: Closing both legs of a spread before expiry to avoid unwanted leg assignments.

Each strategy has risk-reward implications that traders must balance depending on market volatility, directional bias, and portfolio goals.

Tax Considerations and Recordkeeping

Expired options may have unique tax treatment depending on the jurisdiction. In most commonwealth and Western tax codes, expired options result in capital gain or loss equal to the premium paid (for buyers) or received (for sellers). Accurate recordkeeping is essential to report net gains or deduct allowable losses at fiscal year-end.

Advanced traders often utilise expiration events for tax-loss harvesting, closing losing contracts just before expiry to lock in deductibles. However, tax rules are complex and vary—engaging a qualified professional is strongly recommended.