What Is the Meaning of Expiration Time in Options Trading?
Options are financial contracts (derivatives) that allow you to purchase or sell any underlying asset (stocks, indices, currencies or commodities) at a predetermined value by a fixed date. These financial instruments cushion traders against major losses due to market fluctuations. Every option has an expiration time and date, before which traders must consider executing them. However, option buyers do not have an obligation to execute the contract.
This blog takes you through a comprehensive understanding of expiration time in options. Keep reading!
What Is the Expiration Time in Options Trading?
There is a thin line of difference between expiration time and expiration date. The expiration date is the last day for an option’s owner to exercise their rights. In contrast, the expiration time is the period which includes both date and time before an option contract turns void and holds no value. Traders always try to trade their options contracts before this period to earn profits.
Usually, the last Thursday of every month is the expiration date for all 1-month options contracts. On the expiry day, options expire at the closing time of the market which is 3:30 PM in India.
However, if this Thursday is a holiday, the stock market will consider the preceding Wednesday as the expiration time in options trading. After this period, options traders cannot earn any profit on selling options they hold.
How Do Options Work?
Like futures, options are financial instruments that derive their value from underlying assets such as stocks. A trader can purchase or sell these contracts depending on the underlying asset. Options are not obligations; they only give you the right to purchase stocks at a future date. They also try to save traders from facing major losses due to market turmoil.
Now, let’s take a look at how options work.
Suppose you are planning to sell some assets, say stocks, on a future date. To execute this plan in usual circumstances, you must purchase them at a lower price and sell them at a high value. However, the stock market is quite unpredictable, there is no assurance about their prices in future dates. The price of your stock may fall on a future date; this can lead to major losses.
You can buy or sell stocks with a call or put option to avoid any losses due to this unpredictability. With this, you can buy or sell these stocks at any time before the expiry date at a fixed price.
Let us say that the price of a stock is currently ₹100. If a trader has a bullish sentiment on that stock, they can buy a call option with a strike price of ₹110.
If the price of this stock goes up to ₹130, the call option buyer can exercise their contract and buy these shares at a lower price of ₹110. Subsequently, they can sell these shares at ₹130 to make a quick buck. If a trader has bearish sentiments, they can instead hedge their losses by selling off shares using a put option.
What Are the Different Types of Options?
There are two types of options that you must know to clearly understand options trading. These are as follows.
- Call Option
A call option is a contract that allows traders to buy stocks at an agreed-upon price on a future date. Both parties agree upon a strike price and settle the deal by paying a premium to the seller, who is also an options writer.
When the value of assets rises, option holders purchasing these stocks stand to profit. This is simply because; they can purchase stocks at a price lower than their current market price. However, this is a loss for the option writer.
It is also important to remember that one must purchase a stock with a call option before its expiration time ends. After expiry, these options will stand null or void.
- Put Option
Unlike call options, buyers of put options utilise these contracts to sell stocks at a strike price by a predetermined future date. Using put options, a trader can sell stocks on a future date at a predetermined price before its expiration date. This lets options buyers make a profit when an asset’s market price is lower than its strike price.
However, as a put option is not an obligation, buyers can avoid using them when their market value is higher than the strike price. In such instances, they can sell their securities without put options.
What Are the Advantages of Using Options?
Here are some noteworthy advantages of using options for trading:
- Hedges against Losses
As stated earlier, options are not obligations. They help traders strike a deal at a given price against market fluctuation. Without options, purchasing securities on a future date can be highly risky as we cannot fully predict market trends. Therefore, traders need these contracts to avoid major losses. Options act as a cushion and lower losses by allowing you to a strike price beforehand.
- Low Entry Cost
Options derive their qualities from their underlying assets. If you are purchasing these actual assets, you would need to pay a huge amount. Compared to that, options allow traders to enter positions in stocks with small amounts.
Options trading allows investors a high degree of flexibility to trade with various investments as per the market trends. However, investors must be well aware of the market patterns and can determine changes in short time spans.
What Are the Disadvantages of Using Options?
Despite the above advantages, traders must be mindful of the following risks or disadvantages associated with options.
- Too Complicated for Beginners
A trader needs to be quite accurate in predicting market movements to make intelligent decisions on executing call or put options. This requires advanced knowledge about market movements. However, predicting it accurately can be complicated even for seasoned traders.
- Lower Liquidity
Much fewer people trade with options compared to stocks. As a result, the options market is not as liquid as expected from traders. Consequently, traders may have to sell stocks at a lower price than the purchase price of securities on exchanges.
Every option comes with an expiration time, beyond which, traders cannot earn profits as they turn null and void. Furthermore, trading with options involves clear knowledge of this marketplace. Therefore, seasoned traders who have proper knowledge about market movements can consider trading with options. One needs to analyse and predict the upcoming trends and execute plans accordingly.
Frequently Asked Questions
What are the types of put options?
Put options are of two types. They are as follows:
In-the-Money (ITM) put options: For options whose assets have a higher strike price than their market price.
At-the-Money (ATM) put options: These are put options where the strike price is higher than the market price by a value equal to the premium paid.
When does a trader exercise a call option?
When a trader predicts that the price of an asset will rise in the future, they will use a call option. In short, traders use call options when they have bullish sentiments for an asset.
How do options help against hedging?
Options are a haven for investors for hedging against market fluctuations. It helps lower the risk of major losses in open markets by fixing a price to sell or purchase stocks or commodities in the future.
Can beginners trade with options?
Yes, beginners can also trade with options. However, they would need professional guidance from financial experts to avoid making major losses from options trading. These experts must be well aware of the market patterns and able to study and predict the same accurately.