What is Expiry Day Trading in F&O?
In India, expiry day trading in F&O happens on the last Thursday of the month. It is a crucial day for traders as it marks the last trading day before contracts expire. This day can see heightened volatility and trading activity as positions are 'squared off' or 'rolled over' to new contracts. Seems pretty overwhelming, right? Well, don't fret. Read this detailed article to learn everything about Expiry Day Trading and understand the key concepts in simplified terms.
What is Expiry Day Trading in F&O?
Expiry day trading in F&O encompasses two main instruments: futures contracts and options contracts. Let's break down how expiry day trading works for each:
For Futures Contracts, the expiry day is the last day to deliver the underlying asset (like a stock or commodity) at a price agreed upon when the contract was created. Traders often open and close positions on the same day to take advantage of short-term price changes. This is known as squaring off positions. Hedgers, who want to protect themselves from price changes, commonly use this strategy before the delivery obligation starts.
Options Contracts give the buyer the right, but not the obligation, to buy (call option) or sell (put option) the underlying asset at a specific price (called the strike price) by the expiry date. Expiry day trading for options focuses on the price movements of the option itself, rather than taking delivery of the asset.
Here are two main approaches:
- Speculating on Price Movements: Options traders can buy or sell options contracts based on their predictions of the underlying asset's price movement before expiry. If their prediction is correct, they can potentially profit by selling the option at a higher price (bought cheap, sold dear) or exercising the option to buy/sell the underlying asset at a favourable price.
- Taking Advantage of Time Decay: As the expiry date approaches, options lose value, a concept known as time decay. Traders can exploit this by selling options that are likely to expire worthless, especially those that are significantly out-of-the-money (OTM).
Understanding expiry day trading means recognising factors like liquidity, market sentiment, and external events that influence market behaviour on this day. Tools like the Market Mood Index (MMI) can provide insights into market sentiment, helping traders anticipate potential movements. Being aware of these factors helps traders make informed decisions and manage risks effectively.
Key Concepts in Expiry Day Trading
| Concept | Explanation | Importance | How it Affects Trading |
| Strike Price | The predetermined price at which the holder of a call option can buy or a put option can sell the underlying asset by the expiry date | Determines the option's intrinsic value; if an option is in-the-money (ITM), out-of-the-money (OTM), or at-the-money (ATM) at expiry | Options become more valuable as the underlying asset price moves closer to the strike price on expiry day |
| Premium | The cost of buying an option contract, calculated as the difference between the option price and the underlying asset's current price | Reflects the time value (potential for future price movements) and intrinsic value of the option | Higher volatility and more time until expiry generally lead to higher premiums; Affects profitability as it's the upfront cost of the option |
| In-the-Money (ITM) | An option contract is considered ITM if the underlying asset's price is already favourable for the option holder at expiry. (Call option: underlying price > strike price; Put option: underlying price < strike price). | ITM options hold intrinsic value and are more expensive than OTM options. More likely to be exercised at expiry; offer potentially higher profits. | Less sensitive to price movements of the underlying asset as expiry approaches, as they already have intrinsic value |
| Out-of-the-Money (OTM) | An option contract is considered OTM if the underlying asset's price is unfavourable for the option holder at expiry. (Call option: underlying price < strike price; Put option: underlying price > strike price). | Lower cost but higher risk; less likely to be exercised at expiry | OTM options are cheaper but riskier, often expiring worthless. More sensitive to price movements of the underlying asset compared to ITM options. |
| At-the-Money (ATM) | Options where the stock price is equal to the strike price; They have minimal intrinsic value and their price is primarily based on time value. | Balanced risk/reward profile; often used in straddle strategies | More sensitive to price movements of the underlying asset compared to ITM options but less than OTM options; Small price movements can significantly impact their value. |
| Intrinsic Value | The difference between the strike price and the current market price of the underlying asset; It represents the in-hand profit if the option is exercised immediately. | Indicates the real worth of the option at the current moment, Only relevant for ITM options at expiry; As expiry approaches, intrinsic value becomes the dominant factor in option pricing for ITM options. | Directly affects potential profit if the option is exercised before expiry |
| Time Value | The portion of the option premium that reflects the potential for the underlying asset's price to move towards the strike price before expiry | Represents the potential for future gains and decays over time as expiry approaches; Options with more time until expiry tend to have higher time value. | Plays a bigger role in option pricing earlier in the contract cycle; Affects profitability as time value constantly decreases towards expiry |
How to Trade on Expiry Day
Options Trading on Expiry Day
When trading options on expiry day, it's crucial to follow specific practices to maximise gains and minimise risks:
- Exercise Caution: Closely monitor your positions throughout the trading day, especially as expiry approaches. This allows you to identify and capitalise on profitable opportunities or exit positions to secure gains.
- Understanding Option Types (ITM, OTM, ATM): Knowing whether your options are ITM, OTM, or ATM will help you make informed decisions about exercising or holding them until expiry.
- Time Value Decay: Remember that the time value of options diminishes as expiry approaches. This can impact profitability, particularly for options bought closer to expiry.
Below are the benefits of expiry day trading for both option buyers and sellers:
Options Buyers on Expiry Day
A common strategy involves buying options with different strike prices. As the stock price moves favourably, the chances of these options expiring ITM increase. However, as the expiry date approaches, the premium value of options declines rapidly.
Options Sellers on Expiry Day
Option sellers adopt a retrospective approach. They aim to sell multiple contracts at or near the same strike price to collect as much premium as possible. They often sell out-of-the-money (OTM) options, anticipating that these will expire worthless.
Futures Trading on Expiry Day
- Close or Roll Over Positions: Traders need to decide whether to close their futures positions or roll them over to the next contract month. Rolling over involves closing the current position and opening a new one with a later expiration date.
- Manage Margin Requirements: Ensure you meet the margin requirements as expiry day approaches. Failure to maintain adequate margins can result in forced liquidation by your broker.
- Monitor Settlement Prices: The settlement price on expiry day determines the final value of the futures contract. Be aware of how this price is calculated and its implications for your positions.
- Hedge Exposure: Use hedging strategies to manage the risk associated with holding futures contracts until expiry. This can involve taking offsetting positions in related markets.
- Be Aware of Physical Delivery: For contracts that require physical delivery, ensure you are prepared to handle the delivery process. This includes understanding storage and logistics requirements for the underlying asset.
Important Note: Selling options, particularly OTM options, carries inherent risks. Unexpected price movements in the underlying asset can lead to significant losses if not properly managed. So, a well-devised expiry trading strategy is extremely important to mitigate these risks.
FAQs
What if I buy an option on expiry day?
If you purchase an options contract on its expiration day and do not exercise it, the contract will simply expire. The premium you paid for the option is forfeited to the seller, and you are not required to take any further action or pay additional amounts.
Can I hold my option till expiry?
Unlike futures contracts, which must be settled before the expiration date to avoid penalties, options contracts do not incur penalties if not settled. You can choose to let an options contract expire without exercising the right to buy or sell the underlying asset.
Is it good to buy options on expiry day?
As the expiration day nears, the value of an options contract declines due to time decay. This reduction in value can significantly limit potential profits, making it less advantageous to purchase options contracts at the last minute.
What happens if I don't exit the option on expiry?
If you do not exercise a call option by its expiration date, the contract will be null and void. This means you lose the right to buy the underlying asset at the strike price, and the option expires worthless.
What happens on F&O expiry day?
On the expiration day of futures and options (F&O) contracts, there is typically significant volatility in the stock market. The settlement of these contracts can drive the market in bullish or bearish directions, depending on the nature of the contracts and the positions being settled.