How options trades happen.
Understand option expiry, exercise methods, and margin rules.
Introduction
Having gained confidence in buying and selling options, Delilah realizes there's more to options trading than just market predictions.
She recognizes that understanding option expiration dates, exercise processes, and margin requirements is crucial to managing her positions effectively.
Eager to deepen her expertise and avoid unforeseen risks, Delilah delves into these topics.
This lesson will guide us through the mechanics that govern options after they're purchased.
Understanding Option Expiration Dates
Option expiration dates are the deadlines by which the holder must exercise their rights.
The expiration date significantly impacts an option's value, as time decay accelerates as the date approaches.
Historically, options typically expired on the third Friday of the expiration month, while weekly options expired every Friday.
Recently, same-day options have been introduced, expiring each trading day, offering even greater flexibility for active traders.
Exercise Processes
Exercising an option means using your right to buy (call) or sell (put) the underlying asset at the strike price.
In reality, traders rarely exercise, often closing positions near expiration instead. American-style options can be exercised any time before expiry, offering flexibility.
European-style options are limited to expiration day exercises. If an option is in the money and not closed, most brokers will exercise it automatically on your behalf.
These differences affect cost and risk, too.
Delilah Chooses Between American and European Options
Delilah considers purchasing options on GlobalMart Inc.
She must decide between American and European styles.
Preferring flexibility, she opts for an American-style call option, allowing her to exercise at any point before expiration if the stock price rises sufficiently.
This choice aligns with her strategy to capitalize on potential short-term price movements.
Had she chosen a European option, she would have to wait until expiration to exercise, which might not suit her investment goals.
Settlement Methods
Options can settle either through physical delivery or cash settlement. In physical delivery, the actual underlying asset changes hands when the option is exercised.
For stock options, this means transferring shares.
Cash-settled options involve a monetary payment equal to the difference between the market price and the strike price at expiration.
The settlement method affects liquidity and transaction costs. Traders must watch which method applies to their options.