An important determinant of an options price is the time left until expiration. After it has expired, then the option ceases to exist. Expiration is therefore an important date and one that investors should be prepared for, especially if they have not closed the position before it is due to expire.
Whether or it’s a put or call, every options contract has a fixed expiration date. Some options have very short lives that last only a week. Others have expirations that can be years into the future. Nevertheless, all options will expire and it’s important to understand exactly what happens as this date approaches.
By now you probably know the difference between being long or short a call or put option. For instance, the call owner has the right, but not the obligation, to buy or “call” 100 shares of stock for every call option they own. If they call the stock, they have exercised their contract. The Options Clearing Corporation (OCC) will receive the notice and randomly select an option trader who is short the contract to fulfill the terms and deliver the shares. If a seller receives the exercise notice, they have been assigned on the contract.
- Not all options can be exercised before expiration.
- American-Style: Single stock options can be exercised at any time prior to expiration because they are American-style settlement.
- European-Style: Many index contracts can only be exercised at expiration.
Therefore, an option owner can exercise and an option seller might be assigned. Either party may also close the options contract before expiration (provided that the bid-ask for the option is currently greater than zero) through an offsetting trade. For instance, a long call holder, can sell-to-close. The short option holder can buy-to-close.
If a position is not exercised, assigned, or closed before expiration, several things can happen. First, if the option is out of the money, it has no value and there is nothing to do. It will expire worthless, which is likely good news for the seller and not such a favorable development for the buyer. Note: For a refresher on in the money (ITM), out of the money (OTM), and at the money (ATM) options, please see my previous piece, "Buy Value, Sell Junk."
If the contract is at the money, it has no intrinsic value, but might or might not be exercised/assigned at expiration, depending on the motivation of the long option holder. (Note that, in some rare instances, an OTM option might be exercised as well). Lastly, an in-the-money option will be subject to automatic exercise, per rules from the OCC. Therefore, a long option holder should be prepared to have the contract exercised and the option writer will be assigned.