When Options Expire: What Happens to Your Contracts

Financial options are contracts that grant the holder the right, but not the obligation, to buy or sell an underlying asset at a specified price. These instruments are characterized by a finite lifespan, which culminates in a predetermined expiration date. Understanding expiration is crucial for options traders, as it directly influences contract value and outcomes.

Understanding Option Expiration

Option expiration is the date and time an option contract ceases to exist and can no longer be exercised. Standard monthly options typically expire on the third Friday of each month, shifting to the preceding Thursday if it’s a holiday.

Beyond standard monthly contracts, the options market also features weekly options, which generally expire every Friday. For longer-term investment horizons, Long-Term Equity Anticipation Securities (LEAPs) are available, offering expiration dates extending beyond one year.

The ability to exercise an option is determined by its style. American-style options provide the holder with the flexibility to exercise the contract at any time up to and including the expiration date. In contrast, European-style options restrict exercise to the expiration date only. Most equity options are American-style, while many broad-based index options are European-style.

Determining Option Outcomes

At expiration, an option’s status is defined by its “moneyness.” An option is considered “In-the-Money” (ITM) if exercising it would result in immediate profit. For a call option, this occurs when the underlying asset’s price is higher than the strike price. Conversely, a put option is ITM when the underlying asset’s price is lower than the strike price. ITM options possess intrinsic value.

An option is “Out-of-the-Money” (OTM) if it has no intrinsic value, meaning it would not be profitable to exercise. A call option is OTM when the underlying asset’s price is below its strike price. For a put option, being OTM means the underlying asset’s price is above the strike price. When the strike price is exactly equal to or very near the underlying asset’s price, the option is considered “At-the-Money” (ATM).

At expiration, OTM options expire worthless, meaning the option buyer loses the premium paid. ITM options are typically subject to automatic exercise, ensuring the option’s intrinsic value is realized for the holder unless specific instructions are given otherwise.

The Expiration Day Process

On the expiration day, the final settlement price of the underlying asset is determined, often based on its closing price. However, some index options may settle based on a specific value calculated on Friday morning, meaning their last trading day is the preceding Thursday. Option holders who do not wish for their ITM options to be automatically exercised must submit “do not exercise” (DNE) instructions to their brokerage firm. These instructions, including any exercise requests for ATM or slightly OTM options, have a cut-off time. The Options Clearing Corporation (OCC) sets this at 4:30 p.m. Central Time on expiration day, though brokerage firms may impose earlier deadlines.

Once exercise instructions are processed, the assignment process begins for option writers, or sellers. If an option they wrote is exercised, the writer is assigned the obligation to buy or sell the underlying asset at the strike price. This assignment is generally random among all eligible option writers. Writers of American-style options face the possibility of early assignment at any time before expiration.

The outcome of an exercised or assigned option varies based on the underlying asset. Equity options result in physical delivery of shares. In contrast, index options are cash-settled. Following exercise or assignment, accounts are financially impacted through corresponding debits or credits of cash or stock. Any margin held by the clearing firm is released back to the trader’s free balance upon expiration.