What Happens When Call Options Expire?

When an investor engages with call options, understanding their expiration is fundamental to managing potential outcomes. A call option grants the holder the right, but not the obligation, to purchase an underlying asset, such as a stock, at a predetermined price, known as the strike price, before a specific date. This expiration date signifies the final moment the contract is valid, after which it ceases to exist. The fee paid for this right is called the premium, and it represents the maximum loss for the option buyer.

Expiration Outcomes for Holders

For the holder, or buyer, of a call option, the expiration date brings several potential scenarios, each with distinct consequences. If the underlying asset’s price at expiration is above the call option’s strike price, the option is considered “in-the-money” (ITM). In this favorable situation, the Options Clearing Corporation (OCC) facilitates an automatic exercise of the option. This means the holder automatically purchases the underlying shares at the lower strike price, provided the option is in the money by at least $0.01. The shares are then delivered to the holder’s brokerage account.

Conversely, if the underlying asset’s price is below the strike price at expiration, the call option is “out-of-the-money” (OTM). In this case, the option expires worthless. The holder loses the entire premium paid for the option, and no shares are exchanged.

When the underlying asset’s price is exactly equal to the strike price at expiration, the option is considered “at-the-money” (ATM). Similar to out-of-the-money options, ATM call options expire worthless. There is no financial incentive to exercise the option if the market price equals the strike price, as purchasing the shares would offer no immediate profit.

Expiration Outcomes for Writers

For the option writer, or seller, the expiration of a call option carries a different set of obligations and potential outcomes. If the call option they wrote is in-the-money at expiration, the writer faces the risk of “assignment.” Assignment means the writer is obligated to sell the underlying asset to the option holder at the agreed-upon strike price.

The OCC assigns the obligation to the writer. This obligation exists regardless of how high the market price of the underlying asset may have risen above the strike price. The writer must deliver the shares at the strike price, even if it means acquiring them at a higher market price if they do not already own them.

Conversely, if the call option written by the seller is out-of-the-money or at-the-money at expiration, it expires worthless. In this scenario, the writer has no further obligation related to that specific contract. The premium initially received for selling the option is retained by the writer as profit. This is a favorable outcome, as the writer profits from the premium without further obligation.

Managing Options Near Expiration

As the expiration date approaches, option holders have several practical considerations and actions to manage their positions. For call options that are in-the-money, a holder might choose to sell the option in the open market before expiration rather than allowing automatic exercise. This approach allows the holder to realize their profit from the option’s intrinsic value without having to take delivery of the underlying shares, which might involve significant capital outlay or additional transaction costs for buying and then selling the shares.

For out-of-the-money call options, the simplest action for the holder is to do nothing and allow the option to expire worthless. Since these options have no intrinsic value, selling them would yield little to no return, and any remaining extrinsic value (time value) diminishes rapidly as expiration nears.

Option holders should closely monitor the price of the underlying asset relative to the strike price as the expiration date draws near. Market movements in the final days or even hours can significantly impact whether an option expires in-the-money or out-of-the-money. Being aware of these price movements allows holders to make informed decisions about whether to sell, exercise, or let their options expire.

Tax Implications of Expired Options

The tax treatment of call options, especially upon expiration, varies depending on whether one is the holder or the writer. For the option holder, if a call option expires worthless, the entire premium paid is considered a capital loss. The classification of this capital loss as short-term or long-term depends on the holding period of the option. If the option was held for one year or less, it’s a short-term capital loss; if held for more than one year, it’s a long-term capital loss.

If a call option is sold before expiration, any gain or loss is also treated as a capital gain or loss. Short-term capital gains are taxed at ordinary income tax rates, which can be higher, while long-term capital gains often benefit from preferential, lower tax rates. If a call option is exercised and the underlying stock is acquired, the premium paid for the option increases the cost basis of the purchased shares. The tax implications then shift to the eventual sale of the stock, with the holding period of the stock determining its capital gain or loss classification.

For the option writer, if a call option expires worthless, the premium received is treated as a short-term capital gain regardless of how long the option was outstanding. If the call option is assigned, the premium received from writing the option is added to the proceeds from the sale of the shares. This adjustment affects the calculation of the capital gain or loss on the underlying stock sold.