What is Expiration Date?
The expiration date, in derivatives trading, refers to the date in which options or futures contracts expire. In other words, the expiration date is the last day that a derivative contract is valid. On the date of expiration, the derivative contract is settled between the buyer and seller.
What are Derivatives?
A derivative is a contract between two parties and whose value is derived from the performance of an underlying entity (e.g., asset, commodities, bonds, indexes, currency, etc.). Derivatives are commonly used for hedging (reducing risk) or speculation. The three main types of derivatives are (1) Forwards and futures, (2) Options, and (3) Swaps. An example of a derivative follows:
ABC Company operates a farm and is a large consumer of soybean (which is subject to volatile price movements). The company enters into an option contract with a farmer to purchase 100 bushels of soybeans at a strike price of $900 on the expiration date of January 19, 2025. If the price of 100 bushels of soybeans exceed $900, ABC Company can exercise the option to purchase 100 bushels of soybeans at the strike price of $900.
Expiration Dates for Options Contracts
The expiration date varies depending on the type of derivative being traded. In the United States, the date of expiration for listed stock options is the third Friday of the contract month. For example:
- Stock options expiring January 2020 have an expiration date on Friday, January 17;
- Stock options expiring February 2020 have an expiration date on Friday, February 21; and
- Stock options expiring March 2020 have an expiration date on Friday, March 20.
Expiration Date and Option Value
Regardless of a put or call option, options with a longer expiration date have a higher time value. The longer the expiration date, the more time an option has to reach its strike price and the higher the time value of the option. Consider two options:
- A May 2020 Call Option (“Call Option 1”) on ABC Stock with a Strike Price of $10
- A September 2020 Call Option (“Call Option 2”) on ABC Stock with a Strike Price of $10
Currently, shares of ABC Company trades at a price of $7. The expiration dates of Call Option 1 and Call Option 2 are shown below:
Since Call Option 2 has a later expiration date, the time value of Call Option 2 is greater. Therefore, Call Option 2 would be valued at a higher option price than Call Option 1.
Options and Futures Nearing the Expiration Date
For American options, the owner can choose to exercise the option on a date up to the expiration date. If the owner of the option does not exercise the option (i.e., if the option is out-of-the-money) on the date of its expiration, the option expires worthless.
For European options, the owner can only exercise the option on the expiration date. If the owner of the option does not exercise the option (i.e., if the option is out-of-the-money) on the date of expiration, the option expires worthless.
For futures contracts, they must be closed on or before the date of their expiration. Alternatively, the contract owner can hold the contract and fulfill the contract by buying/selling the underlying asset of which the contract represents.
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