Understanding Expiry Day in Options Trading
In our previous blog on Futures vs Options, we looked at how options contracts work and what makes them different from futures. One key feature that we explored is that these contracts come with an Expiry Date.
Ever wondered what actually happens on this day? Let's look into it...
On the Expiry Day contracts are settled, positions are closed or rolled over, and traders witness a significant shift in trading activity. This day comes with various repercussions for derivative traders as well as for the Indian stock market as a whole.
Option Expiry Structure
Monthly Expiry
In order to avoid ambiguity and confusion amongst traders, the equity and index options in India expire on the last Tuesday of every month, according to NSE. If the last Tuesday is a trading holiday, then the expiry day is the previous trading day.
Weekly Expiry
Weekly options provide more granular opportunities, and risks, for traders and are very popular for short-term strategies. The NIFTY weekly contract options expire on Tuesday of every week, except when Tuesday is a trading holiday.
What Happens to Options on Expiry?
Since the expiry day marks the closure of contracts, there is significant volatility and price fluctuations experienced by traders in the stock market. Trading in expiring options stops at the end of a trading session at 3:30PM, and holding the option till expiry can lead to a few situations, i.e., the option can be:
In-The-Money
The option has value and, if exercised, the trader makes a profit. For example, a trader buys a NIFTY 10,000 call option. If, on the expiry day, NIFTY closes at 10,300, the option has value; it is In-The-Money.
At-The-Money
The exercise price is very close to the current market price - the option may or may not hold value. Considering our previous example, if NIFTY closes around 10,000, the option is At-The-Money and has little to no intrinsic value.
Out-of-The-Money
The option expires worthless - the buyer does not exercise the option and only loses the premium paid. Now, if NIFTY closes at 9,800, the option is Out-of-the-Money and expires worthless.
Settlement Mechanisms
Cash Settlement
Index options in India, like NIFTY, are settled in cash. So, instead of delivering the underlying asset, the difference between the exercise price and the closing market price is settled in cash.
Physical Settlement
Stock options, on the other hand, involve actual delivery of shares. For example, if a trader holds a stock call option with a strike price of Rs.1,000 and the stock closes at Rs.1,050, the trader may be required to buy the shares at Rs.1,000 as per the contract terms.
Conclusion
Expiry Day often brings higher trading volume, increased volatility, and sudden price movements. For beginners, if you are trading in the options market, know the expiry date of your contract(s). Don’t be the trader caught saying, “Oh I thought it expires tomorrow!” on Tuesday evening – that’s a painful lesson.
