If you have a trading account and are interested in future option trading strategies, expiry trading might interest you. The Futures and Options (F&O) expiry date in share market is a day on which a series of F&O contracts comes to an end.
For newbies, options are derivatives contracts that give their buyers a right without creating any obligation to acquire a specified quantity of the underlying asset at a predetermined price. This comes at a cost that option buyers pay to option sellers—known as a premium. Options, like all other derivatives, have a certain expiration date after which the contracts in the same series become null and void.
For instance, monthly option contracts expire on the last Thursday of every month. Suppose you bought a call option on a stock for the February 2024 series. The contract remains in force until the last Thursday of February, after which it becomes void.
The value of an option has two components:
Of these, the time value reduces with every passing day and as an option contract nears its expiry, the time value comes closer to zero. The intrinsic value, on the other hand, is the difference between the strike price of an option and the market price of the underlying asset.
On the contract expiry day, if you are expecting a large price move amid extreme volatility, a long straddle strategy may come in handy.
In an ATM long straddle, you would buy an at-the-money call option and an at-the-money put option. This is a direction-neutral strategy, meaning, whether markets go up or down, you may not bother much, provided the move is quick and large. Here, your maximum loss would be equal to the premium you paid on the call as well as the put option. On the day of expiry, ATM options often become inexpensive and your breakeven points become narrow. You tend to profit if markets move sharply during the last few hours of the trading expiry.
If you don’t expect any significant move in the market on the day of expiry, then an OTM short straddle may be a sound strategy. In an OTM short straddle, you would sell a call as well as put on the same strike price and collect the premium. You would hope that both options expire worthless, thereby allowing you to keep the premium earned on options writing.
The short strangle strategy involves selling a call and a put for the same expiry at different strike prices. This strategy is suitable for range-bound markets. By writing a call and put at different strike prices, you roughly define a range beyond which you don’t see an expiry closing for the underlying stock or an index.
Here’s a pro-tip
You should use Open Interest (OI) data and changes therein to determine strike prices. Usually, the call with the highest OI offers guidance on potential resistance levels. Similarly, the highest put OI offers clues about potential support levels. Until markets breach the support and resistance levels indicated by the option chain, the short-strangle strategy remains profitable for options traders to the extent of the premium collected.
Sometimes, option traders may exercise their in-the-money options instead of squaring them off, depending on their portfolio preferences. For instance, if you held a call option on Reliance Industries, which is now ITM, instead of closing your position, you may exercise the option and take delivery of the stock. This strategy is suitable only for investors looking to create long or short positions in the cash market.
Discussed above are some of the best-known expiry-day option strategies. That said, we strongly encourage you to adequately back-test all strategies before incorporating them into your trading routine.
Under normal circumstances, option writers are more active on an expiry day. As discussed earlier, options lose time value near expiry, so the only variable that tends to affect option prices is their intrinsic value.
If you are reasonably sure that markets won’t break a range, short-straddle and short-strangle strategies might work for you on the day of expiry in share markets. On the other hand, if you sense event-specific volatility, then you may consider an ATM long straddle. For instance, if market expiry happens to be on the budget day, which is usually a day marked with very high volatility, you may bet on the ATM long straddle.
An expiry-day trading might look quite straightforward since only a handful of option strategies can be employed on this day. But you shouldn’t take it lightly. Before entering a trade on the day of expiry, you should check the OI, and volatility and also note down specific events that may weigh heavily on the markets.
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