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.

Sign in to follow this  
Followers 0

Options Expiration Date And How It Influences The Price


To understand how the expiration date of an option influences the price, one first needs to understand how the price of an option is calculated in the first place. While the standard formula to calculate options prices, the Black-Scholes model, is very complex and requires advanced knowledge of statistics, for most traders it is sufficient to understand the basics involved.

Elements of the price of an option

 

When someone who is options trading buys or sells an option, the price of it is determined by a few factors.

These are:

  • The intrinsic value of the option.
  • Plus: the extrinsic value, which depends on:
  • The time to expiration.
  • The risk-free interest rate.
  • Volatility.
  • Dividends.

 

Only ITM options have intrinsic value. Let us assume the share price of company ABC is currently 100USD. A call option with a strike price of $80 will have an intrinsic value of $20.

 

If that option sells for $24, therefore, the intrinsic value is $20 and the rest ($4) is extrinsic value, of which time value, determined by the time to expiration, is an important component.

 

Time value

 

If one looks at a typical options chain, it is immediately clear that the more time there is until expiration, the more expensive the options become. The newer 1-week options are, everything else being equal, much cheaper than 1-month options, which are in turn much cheaper than 3-month options.

 

This is simply because with more time to expiration the price of the underlying asset has more scope to move up or down. The options writer needs to be compensated for this risk, otherwise there is little sense in writing (selling) an option.

 

Time decay

 

When a trader therefore buys a call or put option, a certain percentage of the purchase price is for time value, i.e. to compensate the options writer for the risk he is taking during the time left to expiration.

 

What is vital to understand here is that the closer to expiration the options come, the less time value they will have. Even if the price of the underlying asset does not move a single cent, your call or put option will lose its time value component as the expiration date approaches and eventually it will expire worthless. This is referred to as the time decay of options.

 

For options buyers time decay is their biggest enemy. The price of the underlying has to move beyond the strike price of their options by the expiration day, or they will become worthless. For options sellers this often becomes their best friend: all they need is for the underlying price to remain on the ‘right’ side of the strike price long enough and they will keep the full options premium.

 

What is interesting to note here is that options tend to suffer more time decay during the last 30 days of their lifetime than during earlier months. This is why many options sellers only sell options with an expiration date that is no more than 30 days away. Options buyers, on the other hand, need as much time as possible to give their options an opportunity to reach their strike price.

Summary

 

It is important to understand how time to expiration influences the value of options. An option buyer is literally ‘buying time’ when he or she purchases longer term options, while an options seller will get bigger premiums for a longer term option than for a short term one, but this means additional risk because there is more time left for things to go wrong.

 

This article presented by Marcus Holland, the editor of FinancialTrading.com – a new but fast growing education resource on all aspects of financial trading

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

  • Pre-earnings Momentum Trade in Netflix

    Netflix has earnings due out Monday, October 16th, after the market closes. Seven calendar days before then would be 10-9-2017. Coming off of a nice win in THO, now it's time to look at the company's remarkable history of momentum into earnings events and how it compares to FAANG more broadly. 

    By Ophir Gottlieb,

    • 1 comment
    • 530 views
  • Microsoft Pre-earnings Momentum Trade

    Microsoft has earnings due out on October 26th, 2017, after the market close, according to Wall Street Horizon. 7-days before then would be October 19th, 2017. Microsoft is the forgotten mega tech -- the third largest company in the world behind Apple and Alphabet, but it doesn't fall into any fun Acronyms, like FANG, or FAANG. 

    By Ophir Gottlieb,

    • 14 comments
    • 778 views
  • Options Greeks Explained

    Options Greeks measure the different factors that affect the price of an option contract. Unfortunately, many traders do not know how to read the Greeks when trading. The following infographic provided a brief explanation of the most important Greeks: theta, delta, gamma vega and rho.

    By Kim,

    • 0 comments
    • 313 views
  • Option Trade After Earnings in AutoZone

    AutoZone Inc (NYSE:AZO) has earnings due out tomorrow, 9-19-2017 before the market opens and we can look at a slightly advanced option trade that starts two calendar days after AZO earnings (9-21-2017) and lasts for the 19 calendar days to follow, that has been a winner for the last 3 years. 

    By Ophir Gottlieb,

    • 0 comments
    • 406 views
  • Why Winning Ratio Means Nothing

    A lot of options traders consider 90% probability strategies a Holy Grail of trading. After all, if you can win 90% of the time, you should be able to grow your account very quickly, right? Well, not only this is not true, but in fact, winning ratio alone tells you NOTHING about your chances to be profitable. 

    By Kim,

    • 0 comments
    • 1,951 views
  • Post Earnings Option Trade in Facebook

    For Facebook Inc, irrespective of whether the earnings move was up or down, if we waited one-day, and then sold an one-week at out of the money iron condor (using weekly options), the results were quite strong. This trade opens two calendar after earnings to try to let the stock find equilibrium after the earnings announcement. 

    By Ophir Gottlieb,

    • 0 comments
    • 333 views
  • The Incredible Option Trade in VXX

    The iPath S&P 500 VIX Short Term Futures TM ETN (NYSEARCA:VXX) is referred to as "the VXX.". The obligation of the VXX is to match the performance of the S&P 500 VIX Short-Term Futures Index Total Return and that is a strategy index which maintains positions in the front two-month Volatility Index (VIX) futures contracts. 

    By Ophir Gottlieb,

    • 0 comments
    • 763 views
  • The Art of Trading Decisions

    One of my basic tenets in teaching people how to trade options is that rules and guidelines should not be written in stone and that there are valid reasons for accepting or rejecting some of them. When I offer a rationale or explanation or suggest course of action, it is because I have found that this specific suggestion has worked best for me.

    By MarkWolfinger,

    • 0 comments
    • 351 views
  • Trade Iron Condors Like Never Before

    Iron Condors have gained a lot of popularity among professional money managers and retail investors. It is a market neutral strategy that allows you to profit when the underlying price moves sideways. Iron Condors usually have a limited risk and a high probability of success.

    By Kim,

    • 2 comments
    • 6,609 views
  • Early Exercise: Call Options

    How would a trader like you decide to do early exercise? Say you bought calls when they were trading in the 1.0 -> 2.5 range, now underlying has risen so that calls trade bid-ask at 4.0 / 4.8 and there is strong possibility of it going higher. Also assume in another case that they trade in the 6.0 to 7.0 range.

    By MarkWolfinger,

    • 0 comments
    • 1,854 views

  Report Article
Sign in to follow this  
Followers 0


We want to hear from you!


There are no comments to display.



Your content will need to be approved by a moderator

Guest
You are commenting as a guest. If you have an account, please sign in.
Add a comment...

×   Pasted as rich text.   Paste as plain text instead

  Only 75 emoticons maximum are allowed.

×   Your link has been automatically embedded.   Display as a link instead

×   Your previous content has been restored.   Clear editor

×   You cannot paste images directly. Upload or insert images from URL.

Loading...