Option terms and expiration dates go hand in hand. These aspects are unique to options and relate to the limited time span of the option contract. An option expiration has unique implications for both buyers and sellers.
The option term is the period during which an option is active. During this term, the option changes in value based on fluctuations in the price of the stock it represents. The most important distinction to note regarding the option term is whether the option is American style or European style. American style options may be exercised at any time during the option term, while European options may only be exercised at the expiration date.
The expiration date is the date when the option term ends. After the expiration date, the option is no longer active. When one option expires, trading switches over to the next options market. For example, after the March options on Coca Cola stock expires, trading switches over to Coca Cola's April options market. Note that investors may choose to trade options markets with distant expiration dates, but most trading takes place in the options market with the closest expiration date.
Option expiration has different implications for buyers and sellers. For buyers, expiration is the last chance to exit the option position or exercise the option to buy the underlying stock. For sellers, expiration automatically closes out their position. After an option expires, the buyer no longer has the right to exercise the option and, therefore, the seller retains the premium and no longer has to worry about the risk of exercise.
Time vs. Option Value
A certain proportion of an option’s value known as the time value decreases throughout the option term. The time value decreases gradually at first and then the rate of decay increases as the option term nears the expiration date. At expiration, the time value reaches zero and the only value left on the option is the intrinsic value derived from the underlying stock price.
Adam Parker is a writer from Virginia. He holds a Bachelor of Science from James Madison University. Parker has written articles for online sources including The Motley Fool, Gameworld Network and Glossy News.