3 Best Strategies for Trading Options on Expiration Day
Option expiration is a time when contracts can be exercised, assigned, and premium transferred. When options expire traders and sellers can stand to lose or make large amounts of money. This transfer of capital needs to be fully understood so traders can be well aware beforehand.
The expiration is when the options contract expires, and before that, with possible expectations, consequences, and decisions for both the buyer and seller of the contract. Day trading options on the last trading day are risky, which a trader must comprehend before getting into that position. In this article, we will direct the 3 most popular ways to trade options on the expiration day.
Dangers of Options Expiration
The expiration date is the precise and exact time at which a derivatives contract stops day trading. The value of the option will be lost if the holder fails to close the contract. Therefore, when trading options, you must carefully remember expiration dates.
All options whether in the money or out are subject to exercising and assignment which can be shocking for the holder.
After expiration, the buyer has the right to exercise the option even after the market close. When an option is exercised, there becomes an obligation to whoever is short the option to buy or sell 100 shares of stock to the option buyer. Exercising 100 shares of stock could be a very large amount of money that surprises the option seller. With exercising, the option buyer has the right to exercise but not the obligation.
After expiration, the seller may be assigned shares of stock if the option buyer decides to exercise their contracts. The option seller will need to buy or sell 100 shares of stock per contract to the option buyer.
What Happens When Options Expire?
Traders know expiration, but it is still hard to understand the importance until they go through the consequences. That is why the question is, what happens when an options expirations? The options' price has two components: the external positions or values known as the time value and the intrinsic values.
On the expiration day, the time value comes to zero. On the contrary, if the option is in the money, it has an intrinsic which will be relatively safe. Otherwise, the option will expire worthless.
From the side of the option buyer, practicing exercising options on the expiry date only makes sense if it is based on intrinsic positions. However, the consequences also depend on the type of options.
In the Money Long Call
If you have an In The Money long call on the expiry date, the premium will be lost at the time of expiration. The option buyer has the right to exercise the option in order to buy the stock.
Out of the Money Long Call
If you have an out-of-the-money long call on the expiry date, the option likely will expire worthlessly. The option buyer has the right to exercise the option in order to buy the stock, but likely will not since the trader will save money just by buying the stock at the current price. Exercising out-of-the-money options results in the trader paying more for the stock.
In the Money Short Call
If you have the short calls in the money on the expiry date, the underlying stock will be sold at the strike price of the option and the option premium will be transferred to the trader's account.
Out of the Money Short Call
If you have the short calls out of the money on the expiry date, the option premium will be transferred to the trader's account. There is still a chance the option can be exercised and the trader will lose the underlying stock. While the chance is very low for out-of-the-money options, there is still a chance.
In the Money Long Put
If you have an In The Money long puts on the expiry date, the premium will be lost at the time of expiration. The option buyer has the right to exercise the option in order to sell the stock.
Out of the Money Long Put
If you have out-of-the-money long puts on the expiry date, the option likely will expire worthlessly. The option buyer has the right to exercise the option in order to sell the stock, but likely will not since the trader will save money just selling the stock at the current price.
In the Money Short Put
If you have the short puts in the money on the expiry date, the underlying stock will be bought at the strike price of the option and the option premium will be transferred to the trader's account.
Out of the Money Short Put
If you have the short puts out of the money on the expiry date, the option premium will be transferred to the trader's account. There is still a chance the option can be exercised and the trader will buy the underlying stock. While the chance is very low for out-of-the-money options, there is still a chance.
In short, if your options are ITM on the expiry date, they will be converted into short or long shares of stock, while if options are OTM, they will disappear from the account.
4 Traps To Avoid on Expiration Date
If you take the options expiration day as an opportunity, from the seller's perspective, it is an anticipating day, but for buying, it is a dreadful task for beginners. Either way, there are some settlement traps you must be aware of and try to avoid.
1. Do not exercise your long options.
It is not a good idea to exercise options on the expiration day. It is not worth it if you are not a professional or big fan of stocks. If you have not brought a call or put into securing a long-term position in the stocks, you are generally better off closing the option trade instead of purchasing the shares.
Moreover, purchasing shares or exercising options also comes with additional broker fees that are not worth tolerating.
2. European options are different
There are different day trading styles that have influenced the sale and purchase. The majority of traders practice American Style options, but some people prefer European-style option trading. So it is important to know the difference to tackle unpleasant incidents.
Most trades take place in the American style, and all the rules we know can be applied to it, but the European style has some variations. Following the European style binds you to exercise options at the options expiration date, and Americans give liberty to trade at any time.
To avoid turmoil, here we have mentioned some key differences. Go through them and determine the beneficial one for you.
First, the ceasing of trade time is different for Europeans and Americans. As we all know, when it comes to 30-day option trading, the third Friday of the month is specified for the options expiration day in American style. On the contrary, European-style trading stops on Thursday preceding the third Friday of every month.
Unlike American option trading, the negotiated price of European options is not a real-world price. Instead, a calculation from Friday's early options trading day is used to determine the final price. This negotiated cost determines options that are ITM.
Therefore, you should be careful not to consider that the Friday morning index options price displays agreed on figures. For this reason, it is better to exit the trades by Thursday afternoon in European contracts.
3. Do not hold positions until the last minute.
Don't fall into an abyss in search of some extra pence. Consider both situations, you have a bad or a losing trade, but you do not want to give with the hope of making benefit at the end of the day.
On the other hand, you have some amount in support, but you think you can still make some more profit before option expiration.
Giving up the trade if there is no prominent futures settlement is expected because the last few days are the worst time to exercise the option trade due to gamma risk. This means that the prices will fluctuate with greater speed in both directions. This supports the chance of overnight profit evaporation increases.
4. Check open options interest.
Many traders do not take the time out to check open interest. Basically, this is the number of open contracts for calls and puts in the open month.
The logic behind this scenario is that stocks will gravitate to or away from the places with the highest open interest.
As the contracts expire worthless at expiration, there is nothing wrong with assuming that the market will move in the direction of loss and pain. Visually the max pain can be seen in the chart below that would cause the call and put options to lose the most amount of money. Stocks tend to gravitate to the max pain since the market favors the market makers.
Liquid options for example AAPL, MSFT, FB, and other well-known names have weekly expiration dates. They also offer options with monthly expirations, which makes settlement every third Friday of the month. It is called OPEX. Practicing trading options these days can be beneficial to improve your position as lots of repositioning strategies take place.
Find a screener of the scanner.
The first thing you need to do is to look for better opportunities. You can do it with the help of the best screeners, for example, FinViz, Tradingview, Benzinga, etc., or you could also do it manually by looking for the stock that looks like they are more volatile, have the best liquidity, or most open interest.
Best Option Trading Strategies
1. Scalping Zero-Day Options
Many traders will play short-term moves on options expiration day in the form of scalping. Scalping options have the ability for traders to make 10-50% in a matter of minutes. There are three hacks for scalping options on expiration day every trader needs to know.
A trader needs a good gauge on technical analysis - Having a good indicator, setup, understanding of candlesticks, price action, and more can give traders an edge in knowing when to enter and exit properly.
As you can see in the example below on Tradingview just applying momentum indicators can help traders gauge which direction the stock is moving. The Ripster EMA Clouds below show a downward direction because the cloud color is red.
Respecting stop losses - Options have a very high chance of expiring worthless which is why traders must respect losses when occurring. Scalping is the act of taking small profits so when a trader allows losses to run too long, those losses have the ability to wipe out previous gains instantly and possibly the whole account. The picture below shows how large of a gain is needed to make up for a loss. This picture should drive home the point that traders cannot let losses run too large.
Having a fast trading platform - Many trading platforms do not have the ability for traders to enter and exit trades quickly enough. The lag time and failure to execute properly can cost the trader huge profits in the long term. Some of the most popular platforms for scalping options include Tastyworks, eOption, and TdAmeritrade.
2. Holding Lotto Options
The term lottery "lotto" options refer to options that are meant to be gambled for the chance of massive profits. On expiration day there have been many cases every single week of options gaining 1,000 to 10,000% return. For just a $100 investment, returns could be $1,000 to $10,000 from it. While these opportunities are hard to find, many traders dedicate a small amount of capital every single week for lottos. These options can go to zero and the trader knows that and is prepared to lose the full investment because of the potential upside.
3. Selling Options
Options lose value the quickest at the time of expiration which presents a huge opportunity for option sellers. Option sellers can collect premium fastest these days with the highest win rate strategies. Some of the most popular option selling strategies include:
Short iron condors
Cash Secured Puts
One of the best-covered call and cash-secured put screeners can be found here to help traders maximize the premium collected every single week.
Options trading day is a beneficial and attractive means of making benefit, but beginners find it difficult. Therefore, we have mentioned the whole guide to tell you about the risk of being late. Always take options expiration dates seriously to avoid unpleasant events. Comprehend the traps you may face on expiration day and the process whose every step is essential to follow for good trading spreads or positions.