Holding an Option Through the Expiration Date (2024)

A stock option gives the holder the right but not an obligation to buy or sell a stock at a specified price. This stated price is called thestrike price. The option can be exercised any time it expires regardless of how close it is to the strike price. The relationship between an option's strike price and the market price of the underlying shares is a major determinant of the option's value. So what happens when your options expire? This article explores the options available to you with your options contracts as they get close to their expiration dates.

What Are Your Choices Before Expiration?

As mentioned above, options are derivatives contracts that give the holder the right but not the obligation to buy or sell an asset (a bond, stock, commodity, or another financial instrument) at an agreed-upon price at a later date. They come in two different forms:

• Call Options: A call option is a financial contract that allows the holder to buy an asset as noted above. Purchasing a call option requires the trader to pay a premium, which is what grants the option holder the rights they have in the contract.
• Put Options: A put option gives the holder the right to sell a stock at a specified price, and has no value if the underlying security trades above the strike at expiry.

As an option approaches expiry, the contract holder must decide whether to sell, exercise, or let it expire. Options can be in or out of the money. When an option is in the money, it can be exercised or sold. An out-of-the-money option or an at-the-money option will expire worthless.

What Happens After Expiration?

There are two possibilities when it comes to options when they expire:

• The price for the underlying security is lower than the strike price
• The price for the underlying security is higher than the strike price

Let's take a look at what that means for call and put options.

Call Options

The contract holder profits when the strike price for a call option is lower than the price for the underlying security. To calculate the gains, take the difference in prices then subtract the amount paid for the premium. This figure can be multiplied by the total number of shares. In this case, the option is in the money.

Exercising the call option allows you tobuy shares for less than the prevailing market price. When the option is in the money and approaches expiration, the holder can either sell the option to lock in the value or exercise the option to buy the shares.

If the underlying security trades below the strike price at expiry means the call option is considered out of the money. The maximum amount of money the contract holder loses is the premium. It would make little sense to exercise the call when better prices for the stock are available in the open market. So if the option is out of the money, the option holder would be better off selling it before it expires.

Put Options

The opposite is true for put options. So when the strike price for a put option is higher than the price for the underlying security, the trader ends up with a profit. In this case, the option is said to be in the money, making it worth exercising. When a put option is in the money, its strike price is higher than the market price of the overall market value.

The put option has no value and becomes worthless if the underlying security's price is higher than the strike price. When this happens, the put option is considered to be out of the money. Just like an out-of-the-money call option, the holder of this kind of put option would fare better by selling it off before the expiration date.

Timing Is Everything

It is important to remember that some options must be exercised at specific times. For instance:

• An American-style option can be exercised any time between purchase and expiry.
• European options can only be exercised at expiry.
• Bermuda options can be exercised on specific dates as well as expiry.

A trader can decide to sell an option before expiry if they believe this would be more profitable. This is because options have time value, which is the portion of an option's premium attributable to the remaining time until the contract expires.

Example of Options

Here's a hypothetical example to show how options work. Let's assume a trader pays $2 for a $90 call option on Company XYZ. Because one options contract represents 100 shares, the trader pays $200 for this investment. Company XYZ trades for $100 in the open market once the option reaches the expiry date. At this time, the call option is priced at its intrinsic value. This means that the trader can:

• Sell the option for $10 ($100 market price - $90 strike price). The trader's profit is $800, or ($10 x 100 shares = $1,000 - $200 initial investment).
• The trader can also decide to exercise the option and hold shares in Company XYZ. To do so, they must pay $9,000 ($90 exercise price x 100 shares = $9,000). In this scenario, the trader makes a paper profit of $800 ($10,000 market price - $9,000 cost basis - $200 for the call option).

Here's another scenario. Let's say the $90 call options fetch $12 each, with one week left until expiry. Of this, $10 is intrinsic value ($100 market price - $90 exercise price). The remaining $2 is time value, which is the market's way of saying it believes Company XYZ can climb another $2 in the time left before the option expires. If the trader exercises the option, the paper profit is $800 (same as above). But if the trader sells the option, the profit is $1,000 (or $1,200 - $200).