Updated: Dec 25, 2022
All options have an expiration date. When you hold an option to the expiration date it will either expire In The Money (ITM) or Out of The Money (OTM). If an option expires ITM something will happen to your account!
It's critical to understand how important options expiration is because you do not want any surprises to your account balance.
The expiration date for an option is often discussed using the term Days To Expiration (DTE). DTE is expressed as a number reflecting the amount of days left before the option expires, for example: 21 DTE means the call or put has 21 days before it expires, 0 DTE means the option expires today. Many of the strategies we use at Good Kids Trading (GKT) involve managing an option contract before expiration. However, sometimes we use theta decay to our advantage and trade shorter dated options.
The underlying (Stock, Futures, Commodity) has a set frequency for expiration. Options could expire daily, weekly or monthly. If you want to trade future dated option contracts you will likely only see quarterly or yearly expiration dates after 60-120 DTE as weekly and monthly timeframes are only added when there is enough demand. Some underlying's do not have more frequent expirations and only have monthly options.
It's important to mention that ANY option that is currently ITM can be exercised early even if there are days or months left before expiration. If you have options that are ITM you should understand the risk and likelihood that an option will be exercised early. Generally options are not exercised early under normal circumstances, but this is something to understand and monitor. We will discuss this in upcoming articles.
The majority of options expire worthless, when an option expires OTM, meaning that options strike price is outside of the underlying's current trade price at expiration the option goes to "heaven" and disappears. Nothing happens to your account, you either collect the premium you were paid, or you lose the money you paid for the option.
When an option expires ITM that is when something happens to your account. You do not have to do anything your broker is normally going to handle executing all of these trades in your account for you over night. If you do not want these trades to happen it is your responsibility to close them before the market closes on 0DTE!!
Lets discuss the basics of ITM Calls and ITM Puts when the market closes at 0DTE. There are countless combinations and variables, we're just going to look at calls and puts for stock options today.
A long call obligates you to buy 100 shares per contract at the strike price. When you allow 1 long call to expire ITM you have agreed to buy 100 shares at that strike price. If you have 5 calls, you are agreeing to buy 500 shares. Make sure you have the capital for this in your account or you will be margin called.
A short call that expires ITM obligates you to sell or short 100 shares per contract at the strike price. When you allow 1 short call to expire ITM you have agreed to sell 100 shares at that strike price. If you have 100 shares of the underlying this strategy is defined as a "covered call" because you have 100 shares to cover your short call. So your 100 shares would be sold at that strike. If you do not have 100 shares your account will be short 100 shares of the underlying the next trading day.
A long put that expires ITM obligates you to sell 100 shares of the underlying at the strike price. If you have 100 shares of the underlying this is referred to as a protective put and your 100 shares would be sold at the strike price. If you do not have 100 shares you will be short 100 shares of the underlying at the strike price.
A short put that expires ITM obligates you to buy 100 shares of the underlying at the strike price. If you are short 100 shares of an underlying a short put would cover your short at the strike of the put. Otherwise you have agreed to buy 100 shares for every short put you allow to expire ITM.
If you have a spread, you are defining your risk where you are agreeing to buy and sell calls or puts using the descriptions above. For example. If you are long the 100 call and short the 105 call and the stock is currently trading at 106 you have agreed to buy 100 shares at $100 and sell 100 shares at $105.
It's very important that you monitor all of your position's Days To Expiration and closely watch any options you have that are In The Money. Understand what will happen when an option expires In The Money and what the option obligates you to do if they are exercised early. Options trading is powerful, trading an options contract is an amazing way to leverage your account, but its also important to understand the risks so you do not end up with a surprise or undesired result.