It’s options expiration day, and it’s time to decide what you want to do with your current positions. Expiration day will be awaited if you are a seller of options. It’s a common fear to buy votes. You should know the steps to take and things to know to avoid any unpleasant surprises coming on the third Friday of each month.
We have compiled a list of the top 4 traps you MUST avoid in this volatile period and some tips on handling any crazy situation.
Don’t exercise your long option
It’s not worth exercising at expiration unless you’re a huge “fan” of the company and stock.
You are better off buying the shares than closing the call option unless you purchased the call for a long-term investment.
European options may differ – be aware
Most people trade American-style options. Some investors, however, prefer European-style options. We want to ensure everyone knows the differences between American- and European-style options.
All the rules that you know about options apply to most of them. Some options, however, are European-style and have some slight differences.
Most index options have European-style exercises. European-style exercising is when you can only exercise your option at expiration, whereas American style allows you to exercise it anytime before the end. It is only for exercise purposes. You are not “stuck” until the end. These are index options, not ETFs. The SPDR S&P 500 Index (NYSE SPY), PowerSharesQQQ Trust Index (NASDAQ QQQ), and iShares Russell 2000 Index Index (NYSE IWM) all follow American-style options.
To avoid any confusion, it is prudent that I point out the critical differences between American-style and European-style options.
The time trading ends for American and European options is different. You may be aware that when the expiration month comes around, American options stop trading on the third Friday at the end of the business day. But there are exceptions. Quarterlies, for example, cease dealing on the last day of the calendar quarter. On the contrary, European index options stop selling on the Thursday preceding the third Saturday of the expiration period. This is important because it’s one day earlier than American options.
The settlement price of European options does not reflect the real-world value. Calculations based on trade data for Friday’s first trading day determine the final settlement. This settlement price is used to determine which options are in the money. Therefore, it would be best if you were very careful not to assume that Friday’s index price is the settlement price. It is safer to close your position on Thursday afternoon when dealing with European Options.
Do not hold positions until the last moment
Let’s be honest. Trading is problematic because it requires a lot of letting go.
Take a look at the two scenarios below. You’re in a losing trade but don’t want it abandoned because you believe you could make money by the end of the trading day. You may have some profits on the table but think that you can still make more before the expiration of options.
The increased Gamma Risk makes it the worst time to close out trades. The value of an option will move faster in either direction during the final days before expiration. Profits can disappear overnight.
Then, let another person trade the last few pennies of value and pray for “the big move.”
Option expiration is excellent if you are a net seller of options like us! We let our positions expire and kept the premiums we collected. We should have an expiration party!
Check open interest
Most traders don’t take the time to look at open interest in options.
This is the total number of contracts open for both calls and puts in a particular month. This is based on the theory that the more significant the “overlap” between the strike prices of the options, the more likely it is that the market will trade at that level when the contract expires.
We know many contracts are worthless when expire, so it is safe to assume the market will move towards an area where option buyers experience the most pain.
Consider rolling your bets
Some investors are convinced that options are superior to stocks simply because they expire. This can be dealt with quickly by rolling your options position.
As time passes and the expiration date approaches, you should not fall into the same trap as many other traders. You can still benefit even if your position continues in favor.
You can benefit from an additional profit by using a ” Rolling ” technique. This can be done even if the expiration is over two or five months away. It would be best if you took advantage sooner rather than later.
Rolling helps you bank your profits. The original capital invested can be used to purchase another option that expires a month further away. Consider whether you own calls or puts. Calls can be “rolled up” at a higher price, particularly if the stock rises. Puts are “rolled down” to lower strike prices.
You can continue to do this while your stock is still rising (for calls) (or falling (for put).
This technique will help you to limit your risk while locking in profits. You’ll maintain the same size position. This benefit is unique to options and not available with any other investment. Options are a significant investment.