The Frenzy of Options Expiration Day Reminds Us: Time Really Is Money

Options expiration usually is a time of confusion for traders and investors.

As you may know, when options expire, so does the opportunity to buy or sell stock. Options, of course, are a derivative of equities, and they give the buyer a great deal of leverage, sometimes 10-times or more than stocks. Options contain two components, intrinsic value and time decay.

Implied volatility helps to price the options accordingly, based on historical moves. Generally speaking, 80% of options expire worthless, but that does not happen until the market closes on expiration day.

But why is there so much volatility around expiration day and anxiety raised during this one day? There are many variables in play here that many don't understand, but the one element that creates so much stress is time.

What about time?

Well, when we talk about expiration, we talk about killing the option to buy or sell stock on a certain date. It's terminal. But there is value in this options even to the end, the time decay element. Options will have "some" value all the way to the close, so they are live, even the lowest probability option. In those conditions options can (and will) be traded. 

This issue of time decay is especially  true for those options trades whose "strike" price equals the stock's going market price, say $20 vs. $20. As the value of the contract chips away over time with the pace of this decay speeding up as the option gets closer to expiring, the trader has less and less time to see a profit from the trade. (For more, see this story from earlier this month.)

On a triple-expiration day, which happens four times a year (the third Friday in March, June, September and December) we have options on stocks, indexes and index futures all expiring on the same trading day. What happens behind the scenes are option market makers preparing for heavy volume due to exercising options or even taking stock for delivery. Volumes tend to rise at expiration. Further, when stock is "put" to you on expiration you may have to sell it the following trading day. That creates more pressure on stocks that tend to spill over after expiration. The merging of index options and futures expiring is an interesting situation, these options trade in big size by institutions each day and week for investment and hedging purposes. We often see these options roll out to the following expiration period, so inventory out, inventory in. The resulting high volatility means wide moves up and down the market.

At the time of publication, Lang had no position in any security mentioned.