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Options Expiration | Everything You Need To Know
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Options Expiration
"Expiration" is a term that you will not hear a stock trader utter…why?
Because when you own shares of stock, that ownership never expires (unless you choose to sell your shares of stock).
So why do options expire?
Unlike purchasing shares of stock, purchasing an option contract is generally used as a shorter-mid term investment. When you buy or sell an option contract (controlling 100 shares of stock), you must agree to an expiration date, as part of that contract.
As the buyer or seller of an option, you can choose which expiration cycle you would like to invest in. For most stock options, there are typically quarterly cycles, monthly cycles, and weekly cycles.
It is not vital to learn why expiration cycles occur in the weeks/months that they do (although we will touch on this a little bit in this post), but rather what is more important is understanding what expiration is and how to choose an expiration date because it becomes pivotal in determining whether or not a trade was a success or failure.
What Is An Expiration Cycle? A Brief History
Expiration cycles can be kind of confusing, so I'm going to do my best to break it down. 1973 is the year that the Chicago Board Options Exchange (CBOE) first started to allow equity trading. When they began, it was decided that when options are traded, there would be a total of four different months that each individual equity option could be traded during, each on a different cycle.
The typical increments for these options were 3 months, 6 months, 9 months, and 1 year. Typical cycles for an option would look something like this:
1. January expiration, April expiration, July expiration, October expiration
2. February expiration, May expiration, August expiration, November expiration
3. March expiration, June expiration, September expiration, December expiration
Expiration Cycles Change - More Cycles!
Options gained popularity through the 70s and 80s as a way for investors to hedge their stock positions in the shorter term. As a result of this, in 1990 the CBOE made a change to the rules so that every stock option would have an expiration cycle in the nearest two months.
From then on, all equity options would have what was deemed a ‘front month’ (the closest month - generally the current month) and a 'back month' (the month proceeding the front month), which made the expiration cycles only slightly more complex.
Another development to expiration cycles spawning from the rising popularity of options in the 90s was the birth of a new type security, called LEAPS.
Long Term Equity Anticipation Security - Even More Cycles!
Long Term Equity Anticipation Security (LEAPS) were introduced as a way to make longer-term investments in stock options (things like indices did not have LEAPS until more recently).
So how long can an option contract actually
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