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The number one reason why some crypto traders tend to avoid trading options entirely is because they’re afraid of the complexities involved with options expiration. With the Option Greeks in play, throwing expiration dates into the mix can certainly be daunting for anyone new to the world of derivatives learning how to extract the most profit when trading them.
What happens to the crypto once the contract expires within the stated strike price? Can any action be taken to keep the option contract active?
Find the answers to these queries and more with our ultimate guide to options expiration, as we explore what happens when options expire — and what you can do as an options trader if you’re faced with a low days-to-expiration options (DTE) contract.
Key Takeaways:
Options are contracts that grant the holder the right to buy or sell an underlying asset at a specific price on or before a predetermined expiration date.
Traders have several choices to consider before an option’s expiration date, depending upon their market outlook and risk tolerance. They can choose to exercise the option, close the option position, let the option expire or roll the option over.
What happens when options expire will depend upon whether the options expire in the money or out of the money.
Options are contracts that grant the holder the right to buy or sell an underlying asset at a specific price on or before a predetermined expiration date. While options may provide traders with greater potential returns, they also carry significant downside risk. These factors are ultimately why options are seen as advanced financial derivatives best suited to experienced traders who understand the risks involved.
Options are a derivative instrument, meaning that the price of an options contract is derived from the underlying asset. An option gives its holder the right (but not the obligation) to buy or sell a predetermined amount of the underlying asset at a specific price, known as the strike price, on or before the expiration date.
A put option grants the holder the right to sell an asset for a specific price on or before the specified expiration date, while a call option grants its holder the right to buy an asset at a certain price on or before the expiration date.
In exchange for this right, options contracts require payment of a premium. The premium is determined by several factors, including how much time is left until expiration and how far away from the strike price the asset is trading in relation to current market prices.
Traders who hold long positions in options contracts look for prices of underlying assets to move above their strike prices before expiration, so they can realize a profit on their position. Conversely, traders with short positions in options contracts look for prices of underlying assets to move below their strike prices before expiration, so they can realize a profit on their position.
The ability to leverage gains with relatively small up-front costs makes options attractive instruments for many traders and investors. However, these same features can also lead to potential losses if the market turns against them. When trading with options it's important for traders to understand how these instruments work, so that they can make informed decisions about when and how much money they should risk with each trade — and protect themselves against any potential losses.
On or before the option's expiration date, traders have several choices to consider, depending upon their market outlook and risk tolerance. Here are the possibilities:
Exercise the Option: If the option is in the money (ITM), the holder can choose to exercise it. This means purchasing (for call options) or selling (for put options) the underlying asset at the strike price.
Close the Option Position: Before expiration, a trader can close their open position in the option by transacting in the open market if it has value. This can be a profitable strategy if the market conditions change, and the option holder no longer believes the option will be profitable at expiration. This would mean selling a bought option or closing a short position.
Let the Option Expire: If the option is out of the money (OTM) at the expiration date (i.e., not profitable if exercised), the option holder can let it expire. However, this means the premium paid for the option is lost.
Roll the Option Over: Some traders may choose to “roll over” their options, which involves selling the current option and buying another option with a later expiration date. A trader will use this strategy when they believe the option requires more time in order to become profitable.
One big reason why options sometimes strike fear among traders is the additional dimension of time that’s factored into the calculation of options premiums. Unlike simply trading shares on the equity market, the options you’re trading can possibly be worth nothing by the time they expire. This is because of their days-to-expiration (DTE), which can cause option premiums to vary considerably the further they are from expiration.
Curious about what happens to options contracts when they expire? In the following section, we’ll take a look at various examples of options at expiration.
If the options contract is expiring in the money (ITM), meaning that the underlying asset is trading above or below the strike price (for call and put options, respectively), then it will automatically be exercised. This means that if you hold a bought call option, you’ll receive the agreed-upon quantity of the underlying asset at the specified strike price.
Short positions in options contracts will automatically be exercised as well, which can result in a loss if your short position is ITM at expiration.
If the options contract is expiring out of the money (OTM), meaning that the underlying asset is trading at or away from the strike price (for call and put options, respectively), then it will expire worthless. No action needs to be taken, as the options contract will simply expire.
Options traders should note that when options are expiring OTM, it’s possible to receive some value from them by selling them in the open market before expiration. This can result in reduced losses for traders with short positions, and potential gains for traders with long positions. However, they must act quickly so that they can take advantage of this opportunity.
Options expiration dates are typically fixed for the third Friday of each month; however, this can vary depending upon the exchange and the underlying asset. In some instances, if there’s a demand, the asset may offer weekly options that expire every Friday so traders can take advantage of the added flexibility when it comes to contracts with different expiration dates to pick from.
All in all, it’s important for traders to know when their options contract is set to expire so they can take appropriate action ahead of time if needed.
When faced with a low DTE options contract, traders have several choices, as outlined above. Each of these alternatives can be beneficial in different scenarios, depending upon the trader's market outlook and risk tolerance. It’s important to remember that options trading carries inherent risks, so it’s essential that traders understand how these instruments work before embarking on any of these strategies.
Before you determine the optimal options expiration date, it’s first important first to understand the Greeks and how Theta plays a part in options premium calculations.
In short, Theta refers to the rate of decline in the value of an option due to the passage of time. It measures the inevitable loss in the premium’s value as time passes.
Because crypto options contracts have a fixed expiration date, each passing day represents one day less for an exponential move in the ideal direction as the contract heads toward maturity. That’s why Theta is represented as a negative number for long positions and as a positive number for short positions.
Now that we’ve established an understanding of Theta decay for options contracts, we can better understand the optimal days-to-expiration that crypto options traders must consider when deciding to purchase or write options. While traders typically have their preferences when it comes to DTE, some experienced options writers live by the 45 DTE rule — because 45 DTE grants options short sellers the right balance of accelerating extrinsic value decline, thanks to Theta decay and a large enough extrinsic value premium to warrant the trade entry.
This 45 DTE rule aside, personal preference will ultimately decide how one chooses their options expiration date. This is because long options traders have to decide whether to give enough time for the underlying crypto to move in the anticipated direction, and if that time is worth the additional premium. Conversely, short option traders will have to determine if the extra premium earned from Theta decay is worth the risk of the underlying asset’s price suddenly becoming volatile.
In an ideal environment, options traders should strive to keep their options from expiring, regardless of whether an option is expiring ITM or OTM. This is because traders will be sacrificing the extrinsic aspect of the options contract, which falls over time (thanks to Theta decay). However, there are situations when attempting to salvage a crypto options trade may do more harm than simply letting it expire. In such situations, it may make sense to simply let the options contract expire. For instance:
The cost of selling the purchased options contract exceeds the cost of letting the option expire worthless.
The risk of getting assigned on written options contracts is becoming increasingly unlikely.
The wide bid and ask spread or lack of liquidity can make closing the option contract extra costly.
Options are powerful financial instruments with the potential to generate significant gains for experienced traders who understand how they work and the risks involved. The expiration date of options contracts is an important factor to consider, as it determines when the contracts will expire and whether they’ll be worth anything at the end.
From explaining the intricacies of options expiration to going in-depth with Theta decay, we hope our guide has been helpful in aiding options traders like yourself assess your ideal DTE.
When analyzing the cost and benefit of trading options (while taking volatility and Theta decay into account), there can be a fine line between deciding whether it’s preferable to salvage an options trade or simply let it expire. Regarding options expiration dates, crypto options traders must weigh their choices in light of the capital they’re risking and the potential upside that can come from that risk.
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