Must-Know for New Derivative Traders: Do Out-of-the-Money (OTM) Options Really Expire Worthless?
What happens on the expiry day to OTM Options?
In the compelling world of trading and investments, there exists a concept that adds an element of intrigue and urgency to certain financial instruments. We're talking about the expiration date - a crucial aspect that determines the lifespan of options and futures contracts. Comprehending the dynamics of expiration dates is essential for any trader or investor looking to navigate this complex landscape successfully.
What is an expiration date?
An expiration date refers to the specific calendar date and time when a trading instrument reaches the end of its journey, rendering all associated contracts null and void. For options and futures, this means that after the expiration date, these contracts lose their validity, leaving traders with no further rights or obligations.
What is DTE?
When evaluating potential options positions, traders don't just focus on the price; they also consider the time remaining until expiration. This period often referred to as "days-to-expiration" or DTE in technical jargon holds tremendous significance in assessing the potential value of an options contract.
What happens on the expiry day to OTM Options?
Now, let's dive deeper into the intriguing realm of options trading and explore what happens on the expiration day, particularly with out-of-the-money (OTM) options. On this fateful day, OTM options, which have strike prices far from the current market price of the underlying asset, generally expire worthless. This implies that the price of these options drops to zero upon expiration.
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Of course, you may notice an apparent value of Rs 0.05 for OTM options close to expiry, known as the Last Traded Price (LTP). However, it's crucial to distinguish LTP from the actual value of the option on expiry. Deep OTM options tend to have a bid-ask range of Rs 0 to Rs 0.05, allowing buyers to acquire the option at the lowest possible price of Rs 0.05. Consequently, the LTP might remain at Rs 0.05 until the session concludes, creating a misconception regarding the option's value. But in reality, the value of OTM options on expiry will be zero.
In most cases, if the premium drops to Rs 0.05, it's advisable to leave the position unchanged. The potential for recovery in these options, particularly on the expiry day, is usually minimal. However, it's important to consider the time remaining until expiration, as well as the difference between the strike price of the option sold and the current market price of the underlying asset. If there is ample time remaining, it's worth noting that there is still a possibility for recovery, which might not be favourable for option sellers.
Understanding expiration dates in options trading unravel a fascinating aspect of the market's time-bound nature. As traders and investors engage in this ever-evolving domain, comprehending the significance of expiration dates empowers them to make informed decisions, navigate risks, and seize opportunities effectively. So, embrace the enigmatic world of options trading, where the ticking clock adds an exhilarating twist to every trade.