SteadyOptions is an options trading forum where you can find solutions from top options traders. TRY IT FREE!

We’ve all been there… researching options strategies and unable to find the answers we’re looking for. SteadyOptions has your solution.

Expiration Surprises to Avoid


Unless buying or selling options with a distant expiration date (LEAPS), each trader understands that the value of an option portfolio becomes increasingly volatile as the time to options expiration decreases. It is important to be aware of specific situations that may crush (or expand) the value of your positions. 

Here are six situations that should be of special concern when expiration day draws nigh.

 

1) Position Size

 

When trading options, the most effective method for controlling risk is paying attention to position size (number of options or spreads bought/sold). Smaller size translates into less profit and less reward. However, successful traders understand: minimizing losses is the key to success.

 

When options expiration approaches, an option's value can change dramatically. The effect of time is far less on longer-term options.

 

Gamma measures the rate at which an option's delta changes. When gamma is high – and it increases as expiration approaches – delta can move from near zero (OTM option) to almost 100 (ITM option) quickly.

 

Option owners can earn a bunch of money in a hurry, and option shorts can get hammered. However, those short-lived options often become worthless. These are the conflicting dreams of option sellers and buyers.

 

The point is that having a position in ATM (or not far OTM) options is treacherous, and reducing the size of your position is a healthy and simple method for reducing risk.

 

Consider reducing position size when playing the higher risk/higher reward game of trading options near expiration.

 

2) Margin Calls

 

Receiving an unexpected margin call is one of those unpleasant experiences that traders must avoid. At best, margin calls are inconvenient. Most margin calls result in a monetary loss, even if it's only from extra commissions. Think of it as punishment for not being prepared

 

When you hold any ITM short option position, there is the possibility of being assigned (and converting an option position to stock) an exercise notice. Early exercise is unlikely unless the option is deep ITM. However, you already know that any option that finishes ITM is subject to automatic exercise.

 

Exiting the trade prior to expiration makes it likely (there is still the chance of being assigned before you exit) that you can avoid the margin call.

 

Most put sellers (conservatively) sell puts only when cash secured. That means: cash to buy shares is already in the account. When cash is available, there is no margin call.

 

Those who write call options are subject to the same assignment risk. If the trader is covered, there is no problem. Upon assignment, the shares already owned are sold to honor the option seller's obligations.

 

When you receive a margin call, many brokers (no warning) sell enough securities (to generate cash) to meet that call. Other brokers automatically repurchase your short options (with no advance warning) before expiration arrives.

 

Bottom line: When you cannot meet the margin requirement, do not hold a position that is subject to early exercise. And never hold that position through expiration (when assignment is guaranteed). Find a way to exit the trade to avoid possible margin calls. For clarity: If margin is not a problem, none of this applies to you.

 

forex-options-expiration.png

 

3) Increased Volatility

 

Pay attention to volatility – both volatility of the underlying stock or index as well as the implied volatility of the options themselves.

 

For option owners volatility is your friend. The fact that stocks are more volatile is enough to raise implied volatility, and that in turn increases the value of your options – sometimes by more than its daily time decay.

 

If you get lucky twice, and the volatile market moves your way, the option's price may increase many-fold. That's nirvana for option owners.

 

However, if you are looking at increased market volatility from the perspective of an option seller, volatility translates into fear. Whether a trader has naked short options (essentially unlimited risk) or short spreads (limited loss potential), he/she must recognize that the market (the underlying asset) can undergo a large, rapid price change.

 

Options that seemed safely out of the money and a 'sure thing' to expire worthless are suddenly in the money and trading at hundreds (or thousands) of dollars apiece. When an index moves 5% in one day (as it did frequently during late 2008), SPX options that were 40 points OTM in the morning were 10 points ITM by day's end. When that happens with an increase in implied volatility, losses (and gains) can be staggering.

 

There is good reason for the shorts to be afraid. One good risk management technique is to buy back those shorts – whenever you get a chance to do so at a low price. Remaining short, with the hope of collecting every last penny of premium, is a high risk game.

 

4) Reward vs. Risk

 

Expiration plays come with higher risk and higher reward. That's the nature of the game. In return for paying a relatively low price for an option, buyers have but a short time for the market to do its magic. Otherwise the option disappears into oblivion.

 

Most new traders believe they are locked into the trade once it has been made. Not true. You should consider selling those options any time that you no longer believe they can make money.

 

Don't sell them for a tiny premium, such as $0.05. For that price, take your chances.  But when real cash is at stake, perhaps when the option is priced near $1, then it's a difficult choice: hold vs. sell.  Make a reasoned decision.

 

Although it seems to be an obvious warning, when buying options near expiration day, please be aware of what must occur to earn a profit. Then consider the likelihood of that happening.

 

The same warning applies to option sellers. Time may be short, but when the unlikely occurs, the loss can wipe out years of profits. When there's just too little premium, cover the short position and leave the last bit of cash on the table. 

 

5) Option Greeks – Delta and Gamma

 

The Options Greeks are used to measure risk. Once measured, it is up to the trader to decide whether risk is acceptable or must be reduced. It's important to understand the greeks of your position and how they change when the underlying moves. It's not necessary to spend hours studying the data. Use the greeks to get a look at the big picture and decide whether your position is ok as is, should be adjusted, or closed.

 

As has already been mentioned, delta and gamma change more rapidly near expiration (if the option is anywhere near the money). Stay alert to these changes.

 

6) News Events

 

When news is released, the underlying stock often undergoes a substantial change in price. If you have a position, or are considering opening a new position, be certain that you know whether news is pending. Such news is most often a quarterly earnings report.

 

If you are a risk avoider, don't hold short options with negative gamma in the face of earnings releases.

 

Summary

 

Expiration is an exciting time for traders who are either long or short options. If you want to play in that arena, understand what you are doing. If you are a more conservative trader, it's easy to exit all trades before options expiration draws too near.

 

Related articles:

Want to learn more?

 

Start Your Free Trial

 

What Is SteadyOptions?

Full Trading Plan

Complete Portfolio Approach

Diversified Options Strategies

Exclusive Community Forum

Steady And Consistent Gains

High Quality Education

Risk Management, Portfolio Size

Performance based on real fills

Try It Free

Non-directional Options Strategies

10-15 trade Ideas Per Month

Targets 5-7% Monthly Net Return

Visit our Education Center

Recent Articles

Articles

  • Cyclical versus Historical Volatility

    The interest in volatility for options trading is logical and understandable. However, the nature of volatility in not universally understood or agreed upon. In fact, it is more complex than most people believe. Options traders think of volatility coming in two forms, historical and implied.

    By Michael C. Thomsett,

    • 0 comments
    • 103 views
  • Pros and Cons of Paper Trading

    My first recommendation to all new SteadyOptions members is to start with paper trading, then start small and increase your allocation as you gain more experience and confidence. Over the years, we had a lot of discussions related to the benefits of paper trading, and this article will discuss some of the pros and cons.

    By Kim,

    • 0 comments
    • 154 views
  • Does “Managing Winners” Add Value to Short Strangles?

    Some option educators suggest short strangles have historically benefited from actively managed exit strategies. A widely popularized approach is to enter S&P 500 strangles at 45 DTE and exit at 50% of the credit received or a 21 DTE time stop, whichever occurs first.

    By Jesse,

    • 2 comments
    • 315 views
  • Fat Tails and Option Returns

    When it comes to calculating likely returns from option activity, traders contend with a variety of variations. Returns may be skewed (with declines in value more likely than increases), or unstable in many forms. Or the outcome might reveal itself in the form of a fat tail.

    By Michael C. Thomsett,

    • 0 comments
    • 215 views
  • What To Do In A low Yield Environment

    Investors over the world are struggling with yield in their portfolios.  Government investments are at historically low levels, with thirty-year treasuries basically declining every year for almost thirty years straight:

    By cwelsh,

    • 0 comments
    • 259 views
  • Option Terminology – Avoiding Confusion

    Options traders may easily fall into the habit of expressing ideas inaccurately. This might seem like a minor point, but in fact. It matters a great deal. Confusing and misleading language may lead to incorrect trade entry, and for those novices following more experienced traders, the use of proper terms is the whole story.

    By Michael C. Thomsett,

    • 0 comments
    • 431 views
  • Option Volatility and the Underlying

    Too often, traders may  make the mistake of associating option volatility with behavior of the underlying issue. However, if you employ a volatility assumption to model how an option is likely to change, remember that pricing models are theoretical. It is only useful for estimating the option risks. It does not indicate how underlying price will move.

    By Michael C. Thomsett,

    • 0 comments
    • 365 views
  • Before You Startup Your Own Investment Company, Read This!

    Often when we have had some success on the market, investors minds' begin to consider turning their solitary pursuit into a fully-fledged business. One that does not only line their own pockets but can help make some serious money for our client as well. 

    By Kim,

    • 0 comments
    • 665 views
  • Measuring “The Market”

    When you hear what “the market” did today, what do you think of? Most of us will think of one or more popular US stock indexes like the Dow Jones, Nasdaq, or S&P 500. But how well do these indices actually represent the total stock market? Dimensional Fund Advisors has created an excellent chart to help us answer this question.

    By Jesse,

    • 0 comments
    • 390 views
  • Managing Volatility Spreads

    Although traders often are attracted to hedged combinations (including spreads), some of the features are misunderstood. The spread may be viewed to manage risk, when in fact selection of an appropriate strategy may provide more potential when picked based on volatility.

    By Michael C. Thomsett,

    • 0 comments
    • 541 views

  Report Article

We want to hear from you!


There are no comments to display.



Create an account or sign in to comment

You need to be a member in order to leave a comment

Create an account

Sign up for a new account. It's easy and free!


Register a new account

Sign in

Already have an account? Sign in here.


Sign In Now

Options Trading Blogs Expertido