When options expire, their fate hinges on whether they're in-the-money (ITM) or out-of-the-money (OTM). ITM options are automatically exercised, executing the contract’s terms, while OTM options lapse worthless—costing the holder only the initial premium.
This guide explores the mechanics of option expiration, strategic choices for traders, and key considerations for managing contracts as they near their expiry dates.
Key Takeaways
- Call options grant the right to buy an asset at a predetermined price, while put options enable selling at a fixed price.
- ITM call options occur when the strike price is below the market price; ITM puts arise when the strike exceeds the market price.
- OTM options (strike price unfavorable to market price) expire worthless, capping losses at the premium paid.
- Traders must decide to sell, exercise, or let options expire as deadlines approach—each choice carries distinct risks and rewards.
- Time value decays as expiration nears, making early action often preferable.
Choices Before Option Expiration
Options are derivative contracts tied to assets like stocks, bonds, or commodities. As expiration approaches, holders face three paths:
- Sell the Option: Lock in profits or cut losses by selling the contract before expiry.
- Exercise the Option: Execute the contract to buy/sell the underlying asset (common for ITM options).
- Let It Expire: Allow OTM options to lapse, forfeiting the premium but avoiding further losses.
Broker Policies Matter
Most brokers auto-exercise ITM options at expiration unless instructed otherwise. Confirm your broker’s rules (e.g., Fidelity’s auto-exercise policy) to avoid surprises.
Post-Expiration Outcomes
For Call Options
ITM: Profit if the underlying asset’s price > strike price. Example:
- Strike: $90 | Market Price: $100 → $10/share profit (minus premium).
- OTM: Lapse worthless if market price < strike price.
For Put Options
ITM: Profit if strike price > market price. Example:
- Strike: $50 | Market Price: $40 → $10/share profit.
- OTM: No value if market price > strike price.
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Managing Expiring Options
Minimizing Losses
- Letting OTM options expire limits losses to the premium paid.
- Avoid exercising OTM calls/puts—market prices are more favorable than the strike.
Portfolio Simplification
- Expiring OTM options reduce decision fatigue in complex strategies (e.g., spreads, straddles).
Settlement Methods
Options settle via:
- Physical Delivery: Transfer of the underlying asset (e.g., shares for calls).
- Cash Settlement: Payment of the profit/loss difference (common for index options).
Clearinghouses ensure contractual obligations are fulfilled post-expiration.
Exercise Timing Variations
- American Options: Exercisable anytime before expiry.
- European Options: Exercisable only at expiry.
- Bermuda Options: Exercisable on specific dates + expiry.
Real-World Example
Scenario: Buy a $90 call on XYZ stock for $2 ($200 total). At expiry:
XYZ trades at $100 → Option is ITM ($10 intrinsic value).
- Sell Option: $1,000 profit ($10 × 100 shares - $200 premium).
- Exercise & Hold Shares: $9,000 cost + $200 premium → $800 paper profit.
Time Value Insight: With one week left, a $12 option might have $10 intrinsic value + $2 time value. Selling early captures time value.
FAQs
1. What if my option expires ITM?
ITM calls/puts are auto-exercised. Calls buy the asset; puts sell it at the strike price.
2. Should I let options expire?
OTM options should expire; ITM options warrant exercise or sale. Early action often beats last-minute decisions.
3. When do options technically expire?
Expiration occurs at 11:59 a.m. on the expiry date, but exercise deadlines may be earlier (e.g., 5:30 p.m. the prior day).
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Final Thoughts
Option expiration triggers automatic exercise for ITM contracts and worthless lapsing for OTM ones. Strategic decisions—selling, exercising, or expiring—depend on market conditions, time value, and risk tolerance. Proactive management is key to maximizing gains and minimizing losses.
Remember: Time decay accelerates as expiration nears—plan ahead!