What happens when options expire?
Posted Oct 4 2021
If the stock price finishes below a call option’s strike price, or above a put option’s strike price, the option expires worthless, and the buyer has lost the cost of purchase. Otherwise, your option is In-The-Money (ITM), and what happens for call or put options at expiry is different.
To realise the profit of In-The-Money call options at expiration, where the stock price is above the call strike price, the buyer can allow the broker to automatically exercise* the contract. This requires enough cash in the options trading account to purchase the stock at the contract’s strike price.
If the value of buying shares is prohibitive, find out if your broker can cash-settle on your behalf, otherwise you will need to sell your options contracts to close your position prior to expiration, or lose out on your the profit of your trade.
For In-The-Money put options at expiration, where the stock price is lower than that put’s strike price, you can (and probably should) exercise the option, which gives you the right to sell the shares to the put-buyer. Since the agreed price is higher than the stock price, this means you are selling them for more than they are worth.
Exercising your right to sell will result in a short position on those shares if you do not already own them, and your broker will credit your account with the equivalent to the contract’s strike price. This will see a net gain to your account, however, a short position in the stock will mean you have exposure to rising share price until the position can be closed. (Remember the whole GameStop debacle.)
Your broker may trigger this exercise automatically, for ITM puts*.
Closing positions before exercise
To avoid the risks and complications which come with exercising an option, you can sell-to-close your options prior to expiration.
If you reach a profitable position ahead of expiration, selling your option can mean you also are cashing in on some of the ‘time value’ remaining on the option, which can offset the initial option cost, as well as slippage from the bid/ask spread. See P/L estimates for a long call and a long put.
*This describes common practices in brokerage, however you should check with your broker as to how your contracts are handled in specific situations. Doing this will mean you sacrifice a small portion of profit, since you will be subject to the bid price set by marketmakers, which is often less than the full value at expiration.