Trading monthly options
The purpose of LEAPS is to allow investors to hedge or speculate over longer periods than just a few months. Despite that imposing name, they are simply regular options that, at the time they are first listed, expire in a future year.
They are usually but not always set to expire in January of a future year. Other than their long lifespan, they are no different from any other monthly option. This makes no difference at all in its behavior. There are, however, others we have not displayed yet, including:.
For GE, turning on the display of quarterly options results in a chain that looks like this:. The sole change is that now the Quarterly options for December 31, are shown as the first line on the chain. Note that if the quarter end fell on a date that would have been a regular monthly expiration date anyway, the option with that date would have been labeled as a monthly option. The special quarterly option for the same date would not have been added, as it would have been redundant. Quarterly options can be useful for portfolio managers who rebalance their portfolios at quarter ends, so that their option positions can be made to coincide with these dates.
Anyone is free to use the quarterly options, of course. The last set of regular options are the weeklies. These expire on Fridays that would not otherwise be the expiration date for any other monthly, LEAPS or quarterly options. Not all stocks that have options have weeklies. They are offered on a stock if the exchanges and option market makers believe there would be a market for them. Originally, weekly options appeared on a Thursday and expired eight days later on Friday of the following week.
Recently, exchanges have been offering multiple weekly options so that at any given time there is an expiration of some type on each of the next six Fridays. When a future Friday comes into the six-week window, if there is not already another monthly, quarterly or LEAPS option that expires on that date, it is added as a weekly.
Turning on the final setting on our option chain, which is to display the weekly expirations, the full chain of expirations for GE looks like this:. Now that we have described all of the possible expirations, the next step is to set out some guidelines for deciding which expirations are most suitable for a given purpose.
This is because that spread is a cost to us. The monthlies have by far the most volume and open interest and, therefore, the smallest bid-ask spreads. There are other considerations that are even more important in selecting expiration dates and strikes which we will discussion next time. These short articles can only hit the high spots in the fascinating world of options.
For a real education, contact your local center about our Professional Option Trader program. Disclaimer This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. In this situation, the underlier is said to have pinned. The risk to the writer seller of the option is that they cannot predict with certainty whether the option will be exercised or not.
So the writer cannot hedge his position precisely and may end up with a loss or gain. There is a chance that the price of the underlier may move adversely, resulting in an unanticipated loss to the writer. In other words, an option position may result in a large, undesired risky position in the underlier immediately after expiration, regardless of the actions of the writer. Sellers of option contracts often hedge them to create delta neutral portfolios.
The objective is to minimize risk due to the movement of the underlier's price, while implementing whatever strategy led to the sale of the options in the first place. For instance, a seller of a call may hedge by buying just enough of the underlier to create a delta neutral portfolio. As time passes, the option seller adjusts his hedge position by buying or selling some quantity of the underlier to counteract changes in the price of the underlier.
However, the cost to the option buyer of exercising the option is not zero. For instance, the buyer's broker may charge transaction fees to exercise the option to buy or sell the underlier. If these costs are greater than the amount the option is in the money , the owner of the option may rationally choose not to exercise. Thus, the option seller may end up with an unexpected position in the underlier and thus risk losing value if the underlier's price then moves adversely before the option seller can eliminate this position, perhaps not until the next trading day.
The costs of exercise differ from trader to trader, and therefore the option seller may not be able to predict whether the options will be exercised or not. A trader has sold 75 put contracts on XYZ Corp. In fact, only 49 of the contracts are exercised, meaning that the trader must buy shares of the underlier. If at the close on Friday, October 19, the trader's position in XYZ stock was short 7, shares, then on Monday, October 22, the trader would still be short shares, instead of flat as the trader had hoped.
The trader must now buy back these shares in order to avoid being exposed to risk that XYZ will increase in price. On the day that an option expires—for U. A small movement of the underlier's price through the strike e. For instance, if an option goes from being in the money to out of the money , the trader must rapidly trade enough of the underlier so that the position after expiration will be flat.