Expiration is a fact that options traders must address. There are three ways to face it – love it, hate it, or be neutral and miss the action. Let’s discuss these ways of addressing expiration, and, in a reader Q&A, explain why your broker may have specific rules regarding trading on expiration day. And check out these “6 Expiration Traps to Avoid“.
Expiration Lovers
Some options trading investors love expiration because it means that the options they sold are expiring worthless. For them, the maximum possible profit has been earned and all risk has been eliminated. Their focus is on what to do for next month’s expiration
Others love expiration because it affords trading action. I’m a believer in taking more conservative approaches, but one cannot argue with the fact that traders love expiration week – again for the action. Now that Weekly options have begun trading on many of the most actively traded stocks and indexes, you can elect to have expiration every week!
Option buyers may not have high probability of success on their side, but they have gamma, a very powerful ally. Gamma and I were raised in different neighborhoods and we are not buddies. But if you are willing to pay the cost (theta) of owning gamma, it can produce some wonderful results – part of the time. There’s nothing quite like owning a 10-bagger. However the truth is the truth. Buying options is not likely to be a profitable venture – unless you have a well above average ability to pick direction and time the market moves.
The danger is that loving explosive gamma can become addictive. Weeklys make the perfect trading vehicle for gamblers. It saddens me to see my favorite investment tool is being marketed to the gambler.
Expiration Haters
Some dislike the approach of expiration. For them, it means the options they bought, and which represented dreams of large, leveraged returns, are soon going to be worthless. Those dreams die hard, and losses can be substantial when traders, being greedy, buy too many options.
Expiration Neutrality
There’s another class of traders. They miss out on all the action. They lead less exciting lives when it comes to trading. However, they sleep better at night and own portfolios that fluctuate in value with less volatility. These traders and investors avoid expiration. The only way to accomplish that is to exit positions before options become more dangerous to hold – and that’s true for both long and short positions.
If you are a conservative trader seeking to make money rather than being entertained by fun and games, you can accomplish that need by buying back your short (and/or selling your long) options several weeks prior to that looming expiration date. Yes, theta gatherers miss out on the most rapid time decay, but in return also avoid the dangers of being short options as gamma is becoming explosive. It’s also true that gamma lovers are giving up the position, just as gamma has begun to achieve its maximum power. However, they do avoid paying that ever-accelerating time decay.
Expiration week and expiration day. Love it or hate it — dive in or avoid it — this is a recurring decision for every options trader.
Please click to page 2 -“Why won’t my broker let me buy calls on expiration?”
Follow Mark on his ‘Options for Rookies’ blog: http://blog.mdwoptions.com
Options Expiration (Continued)
Here’s a recent question a reader sent regarding expiration and certain rules his broker places on trading that day.
Mark,
Why would my broker refuse to allow me to buy call options? They tell me that they don’t allow certain accounts to hold options that may be in the money on expiration day. Can they do that? Why would they do that?
Bill R.
Hey Bill,
Brokers are given leeway in deciding what they do and do not allow. There are rules that everyone must follow. However, brokers are allowed to make any of the rules tighter — they cannot loosen them. Margin rules are an excellent example. A broker may require extra margin for certain positions, but it may never reduce those margin requirements.
Your question affords the opportunity for an interesting conversation. This practice is relatively new among brokers and was never a consideration in the early days of options trading.
Rationale
The broker claims that they adopt this practice to protect you, their valued customer. And to a certain extent that’s true. They want to prevent you from doing something that would be extremely foolish. So foolish that I consider it to be a huge insult to suspect that any customer would be dumb enough to do as they fear.
However, experience has proven that some customers are indeed that ignorant of how options work that they take extra precautions to prevent it from happening. Unfortunately, traders such as yourself get caught in the trap.
Here’s the problem. Let’s say your options account is valued at $50,000, it’s morning on expiration Friday, and that you decide to make a short-term play ( three to four hours) by buying five-lots of an ATM (at-the-money) Google (NASDAQ: GOOG) call option.
You understand that time decay is very rapid, but that gamma can result in sizable gains (and losses) very quickly. So you enter your buy order and the broker rejects the trade. You are confused. Here’s what’s happening:
At the end of the trading day, if:
- The options are in-the-money
- You ‘forgot’ to sell them and thus, still own the options
- The options will be automatically exercised for you (because they are in-the-money)
- You will buy 500 shares of GOOG at a cost of something in the area of $300,000
- Your account cannot pay for those shares
- A margin call is generated
- You must sell the stock to meet the margin call
To protect you from forgetting to unload those call options, they prevent their customers from buying them in the first place. Please understand, this is not true for every customer. It only applies to those who don’t have the ability to meet the margin requirements for buying the shares (or selling short when trading put options).
They tell you that this move protects you and that it protects them. And it does protect the broker. That’s the true reason why this restriction is placed on traders.
How can it hurt the broker? If the customer cannot meet the margin call, and if the stock gaps lower by a large amount at the opening of the market Monday morning (which is when the stock is sold), then you could lose more than the value of your account, go into deficit, and be unable to pay the broker. That’s their risk. That’s the chance they will not take.
To me it’s beyond ridiculous. First the customer has to forget, then the resulting loss has to be larger than the trader’s account value and third, the trader must be unable to pay the debt. That parlay is so far against the odds of happening that there is little need to prevent the trader from buying those calls.
The broker has a much easier solution. Just notify the trader that if he/she is still holding that long position when there are only 15 minutes remaining in the trading day, then these options will be sold (at the market). That’s not as unfair to the trader as the current practice.
Follow Mark on his ‘Options for Rookies’ blog: http://blog.mdwoptions.com
