Stock option expiration explained
Stock option expiration 101
All stock options, thus both call options and put options, have an expiration date. If the option holder does not exercise the right to buy or sell the underlying asset within such expiration date, the option becomes invalid will lose all its value. As such you would basically lose the premium you initially paid to purchase the option contract plus any commissions involved with the transaction through your broker. For an introduction to the world of stock options we suggest you first read our introductory article on stock options trading.
Unless an option is in-the-money, then they aren’t exercised as they hold no value. Recall that a call option is in-the-money when the option strike price is below the stock share price, while put options are in-the-money when the strike price is above the stock share price.
Depending on the option style, stock options can either be exercised only on the expiration date (European style options) or at any given time within the expiration date (American style options).
When do stock options expire
The expiration date of American options is the third Friday of the month indicated in the option contract. If the third Friday happens to be a holiday, then the expiration date is anticipated to the Thursday just before the third Friday of the expiration month.
If you take a look at the available expiration months for any given stock option, you’ll notice that there are at least four months available. All stock options must have at least 4 expiration months at any given time and the expiration months available are based on the expiration cycle to which the stock option belongs to. But what exactly are expiration cycles?
Expiration cycles explained
Since the very first day that stock options began trading back in 1973, they were randomly assigned to one of three expiration cycles: The January cycle, the February cycle or the March cycle.
Such cycles simply indicate the months in which the option contract expires.
Stock options belonging to the January cycle have options available in the first month of each quarter: January, April, July, October (also known as JAJO cycle)
Stock options belonging to the February cycle expire in the middle months of each quarter: February, May, August, November (also known as FMAN cycle)
Stock options belonging to the March cycle expire in the last month of each quarter: March, June, September, December (also known as MJSD cycle)
Back then options expired only in the four months according to expiration cycle that the stock option was assigned to. However, as option trading became more and more popular and to satisfy investors’ demand for hedging shorter-term investments by using options, in 1990 the CBOE (Chicago Board Options Exchange) modified the rules so that each stock option would have the current month and the next following month available for trade. This means that if you look up stock option expiration dates, the first expiration date will be the current month. The next expiration date will be the next month and the third and fourth expiration months will follow the expiration cycle that was assigned to the stock option. As such, in order to identify to which expiration cycle a given stock option belongs to you have to check the third month. If the third month happens to be January then check the fourth month to identify to which expiration cycle the option belongs to.
Let’s go through a quick example to make sure the expiration cycle of a stock option is clear.
Stock option expiration example
It is beginning of May and we are looking at the stock option contracts for Company A.
Since the first two expiration months have to be the current month and the next nearest month, May and June are available. If the third month is July, then the stock belongs to the JAJO expiration cycle. If the third month is August, then it belongs to the FMAN expiration cycle. If instead the third month is September it belongs to the MJSD cycle. The fourth month would follow the expiration cycle as well, so it would be respectively October, November or December.
Let’s say that the stock option of company A is assigned to the FMAN cycle. This means that since it is beginning of May, the four available option contracts available are May, June, August, November. Once the May option contract expires, the available options will be June, July, August, November. Once the June option contract expires, the available options will be July, August, November, February.
Options having more than four expiration months
When a stock option has more than four expiration months it is because the stock has LEAPS available. We’ll cover LEAPS in a separate article but LEAPS are simply options having and expiration date longer than one year. LEAPS usually have January as expiration month and go out as far as three years.