How to choose the expiration date

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Options: Picking the right expiration date

Volatility and Greeks can help make this decision, balancing time and cost.

  • Fidelity Viewpoints
  • – 07/05/2020
  • 1341

Key takeaways

  1. The expiration date is the specific date and time an options contract expires.
  2. An options buyer chooses the expiration date based primarily on 2 factors: cost and the length of the contract.
  3. Volatility estimates, Greeks, and a probability calculator can help you make this decision.

Unlike stocks, exchange-traded funds (ETFs), or mutual funds, options have finite lives—ranging from a week (Weeklys 1 ) to as long as several years (LEAPs). The farther out the expiration date, the more time you have for the trade to be profitable, but the more expensive the option will be. Thus, figuring out the balance between price and time until the contract expires is a key to success when buying or selling options.

Unpacking the expiration date

When do options expire?

Let’s say that on January 1, you bought one April XYZ 50 call for a $3 premium (the cost of an option is known as the premium). This option would give you the right to buy 100 shares of XYZ stock (one contract typically covers 100 shares) at a strike price of $50 at any time before the expiration date in April—regardless of the current market price.

Suppose the underlying stock rose to $60 on March 1 and you decided to exercise your option, which was “in the money” because the strike price was less than the price of the underlying security. Your profit, before taxes and transaction costs, would be $700 ($60 stock price minus the $50 option strike price, less the $3 premium, times 100).

But was the April expiration date the best choice for your strategy? Let’s say that in January, you could also have bought a March XYZ 50 call option for a premium of $2, or a May XYZ 50 call option for a premium of $4. Here are the breakeven prices (the price the underlying stock must hit for the option to become profitable) for these 3 different hypothetical options:

  • March XYZ 50 call with a $2 premium: $52 breakeven
  • April XYZ 50 call with a $3 premium: $53 breakeven
  • May XYZ 50 call with a $4 premium: $54 breakeven

The trade-off for the longer time until expiration is a higher cost and, consequently, a higher breakeven price.

How do you decide which expiration date is right for your strategy? Just as you need to make a price forecast for an underlying stock before picking an option’s strike price, so to do you need to make a forecast of how long it will likely take for your trade to become profitable before picking an option’s expiration date. As always, start with your outlook. Then, determine which specific option would be the most appropriate.

3 tools

Here are 3 tools, among others, that can help you choose the right expiration date for your strategy:

1. Volatility

Your assessment of volatility is one of the most important factors when selecting both your options strategy and the expiration date. Many options traders rely on implied volatility (IV) and historical volatility (HV) 3 options statistics to help them pick an expiration date.

Implied volatility, in particular, can be the X factor in options pricing. It can give you an idea of how expensive or inexpensive an option may be, relative to other expiration dates. Typically, the higher the IV, the more expensive the option.

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For instance, let’s say the March XYZ 50 call has a 30-day IV of 20, the April XYZ 50 call an IV of 40, and the May XYZ 50 call an IV of 90. If XYZ was scheduled to report earnings in May, it might explain why that month’s IV is so much higher than the IV in previous months.

If you think the company is going to report very strong earnings that exceed the market’s expectations, and the stock is going to make a strong move higher as a result, it might be worth your while to purchase the more expensive May contract. By assessing each contract’s IV, you can weigh how much you are willing to pay for the length of the contract.

Furthermore, implied volatility tells you how cheap or expensive the premium is relative to past IV levels. A higher IV indicates a higher options premium. This may sound like a benefit to an option seller. However, you need to consider the trade-off, which is perhaps that a higher-than-normal IV may be due to an upcoming announcement or earnings release that is causing the market to expect a large price move. Thus, you need to weigh the cost against your expectation for the stock to move.

Volatility options statistics are available on Fidelity.com and Active Trader Pro ® .

2. Greeks

A hypothetical call option’s days until expiration, theta, and option price.

Greeks are mathematical calculations designed to measure the impact of various factors—such as volatility and the time to expiration—on the price behavior of options. There are 2 Greeks in particular that can help you pick an optimal expiration date.

Delta, which ranges from –1 to +1, measures an option’s sensitivity to the underlying stock price. If the delta is 0.70 for a specific options contract, for instance, each $1 move by the underlying stock is anticipated to result in a $0.70 move in the option’s price. A delta of 0.70 also implies a 70% probability that the option will be in the money at expiration. Generally, the greater the probability that the option will be profitable at expiration, the more expensive the option will be. Alternatively, the lower the probability suggested by delta, the less expensive the option will likely be.

Theta quantifies how much value is lost on the option due to the passing of time, known as time decay. Theta is typically negative for purchased calls and puts, and positive for sold calls and puts. If XYZ were trading at $50, and a 50 strike call with 150 days until expiration had a premium of $5.30 and a theta of .018, you might anticipate that the option might lose about $0.018 per day until expiration, all else being equal.

The accompanying table reflects how theta tends to behave over time and its relationship to an option’s premium.

To find the delta or theta for an options contract, look at the options chain for a particular stock.

3. Probability calculator

If you want a more precise calculation of the probability that a particular expiration date will be in the money at various strike prices, you can use Fidelity’s Probability Calculator. Go to the options research page on Fidelity.com, select the Quotes and Tools tab, and then enter a ticker symbol or log in to Active Trader Pro.

The Probability Calculator enables you to adjust the stock price target, expiration date, and volatility parameters to determine the odds of the underlying stock or index reaching a certain price. The calculator also allows you to enter different expiration dates to determine the probability of a successful trade.

For example, you can see the probabilities of an underlying stock hitting different breakeven prices (e.g., $52, $53, $54) by March, April, and May. Using this information, you can assess how much you want to pay for the varying expiration dates.

Time to make the decision

Of course, there are other considerations when making an options trade. These include selecting the underlying stock to which the option corresponds, the liquidity of the option contract, the particular strategy you are considering, and the strike price, among others. And it’s critically important to understand all the risks and complexities involved with trading options.

The expiration date choice, in addition to these other decisions, can help you potentially improve the odds that your trade will end up in the money. When choosing the expiration date, it’s about balancing time and cost.

Next steps to consider

Get new options ideas and up-to-the-minute data on options.

Best Expiration Date
for Covered Calls

How to Choose an Expiration Date
When Selling Calls

As with the picking the best covered call strike price, choosing the best expiration date when call writing is largely an issue of first determining what your call selling objectives are.

For most call writers, the natural desire will be to maximize their option income, at least in terms of selecting the expiration date that helps achieve this. And with all else being equal, that means selecting an option with the nearest expiration date.

Covered Calls and Time Decay

One factor that’s critical to understand is an option’s time decay, also known as theta.

Obviously, the closer an option gets to expiration, the less time value it has. But what’s critical to understand is that the rate of time decay actually accelerates as expiration nears.

And the inverse is also important – the farther away an option is from expiration, the slower its rate of time decay.

See the covered call terminology page for related definitions.

So why is this so important when considering expiration dates for covered calls?

Maximizing Income From Writing Calls

There are other factors to consider (addressed below), but if you’re looking to maximize your option income, your best choice will most often be to choose near term expiration dates, say one to two months out.

That’s because your annualized returns will be highest with calls expiring the earliest.

Annualized Return vs Total Return

Although your total return will be higher when writing a covered call with an expiration date farther out, keep in mind that it will take longer to achieve that return.

With a shorter dated option, your returns cover a shorter holding period, so even though these total returns will be less, they’re actually higher on an annualized basis.

Let’s look at a real world example:

Intraday on 1/18/2020 NKE is trading at 84.10/share. So let’s look at the bids on all the available call options at the $85 strike price (and I’m also going to include a $10 commission since that can be a factor, especially if you’re writing a single call that’s set to expire in just a few days):

  • JAN 2020 (4 days away) = $0.31 = 22.76% annualized return
  • FEB 2020 (32 days away) = $1.48 = 18.69% annualized return
  • APR 2020 (88 days away) = $2.88 = 13.69% annualized return
  • JUL 2020 (179 days away) = $4.45 = 10.53% annualized return
  • JAN 2020 (368 days away) = $6.90 = 8.01% annualized return
  • JAN 2020 (732 days away) = $10.50 = 6.16% annualized return

How to Calculate Covered Call Option Premium on an Annualized Basis

When I calculate my covered call income on an annualized percentage basis, I take the total premium received and divide it by the cost of my shares and then annualize that return.

[And if I’ve written the call in the money, I’ll take the extrinsic or time value of the option and divide it by selling or strike price.]

The basic formula looks like this:

(Premium Received/Cost of Shares) * (365/Days Until Expiration)

In the example above, I calculated based on an $8420 cost to acquire 100 shares ($84.10/share + $10 commission) and then reduced the premium received by another $10 to cover the hypothetical commission for selling the call.

(And incidentally, that’s why the annualized rate on the first expiration month was 22% rather than 32% – one-third of the premium went to cover the commission. The more calls you write at the same strike, the less role the commission plays but be sure to always factor in commissions when you’re considering a trade because they really can skew your results.)

Why Choose Longer Covered Call Expiration Dates?

There are other valid reasons why you might consider the best expiration date for covered calls to be a date farther out:

  • Sometimes dividends can be a factor – see this covered calls and dividends page for a more detailed explanation.
  • For certain personalities, selecting a longer dated expiration results in more peace of mind as a lot of short term volatility can simply be ignored. Although there can be great opportunities in writing a new covered call position each month (or rolling an existing one), some might consider it uncertain and stressful.
  • And probably most important, and most pragmatic, choosing an expiration date farther out allows you to select a higher strike price. The higher the strike price you write calls at, the more you allow yourself the ability to participate in any capital appreciation of the stock.

Options Expiration | Everything You Need To Know

“Expiration” is a term that you will not hear a stock trader utter…why? Because when you own shares of stock, that ownership never expires (unless you choose to sell your shares of stock).

So why do options expire?

Unlike purchasing shares of stock, purchasing an option contract is generally used as a shorter-mid term investment. When you buy or sell an option contract (controlling 100 shares of stock), you must agree to an expiration date, as part of that contract.

As the buyer or seller of an option, you can choose which expiration cycle you would like to invest in. For most stock options, there are typically quarterly cycles, monthly cycles, and weekly cycles.

It is not vital to learn why expiration cycles occur in the weeks/months that they do (although we will touch on this a little bit in this post), but rather what is more important is understanding what expiration is and how to choose an expiration date because it becomes pivotal in determining whether or not a trade was a success or failure.

What Is An Expiration Cycle? A Brief History

Expiration cycles can be kind of confusing, so I’m going to do my best to break it down. 1973 is the year that the Chicago Board Options Exchange (CBOE) first started to allow equity trading. When they began, it was decided that when options are traded, there would be a total of four different months that each individual equity option could be traded during, each on a different cycle.

The CBOE in 1973

The typical increments for these options were 3 months, 6 months, 9 months, and 1 year. Typical cycles for an option would look something like this:

  1. January expiration, April expiration, July expiration, October expiration
  2. February expiration, May expiration, August expiration, November expiration
  3. March expiration, June expiration, September expiration, December expiration

Expiration Cycles Change – More Cycles!

Options gained popularity through the 70s and 80s as a way for investors to hedge their stock positions in the shorter term. As a result of this, in 1990 the CBOE made a change to the rules so that every stock option would have an expiration cycle in the nearest two months.

From then on, all equity options would have what was deemed a ‘front month’ (the closest month – generally the current month) and a ‘back month’ (the month proceeding the front month), which made the expiration cycles only slightly more complex.

Another development to expiration cycles spawning from the rising popularity of options in the 90s was the birth of a new type security, called LEAPS.

Long Term Equity Anticipation Security – Even More Cycles!

Long Term Equity Anticipation Security (LEAPS) were introduced as a way to make longer-term investments in stock options (things like indices did not have LEAPS until more recently).

So how long can an option contract actually be with LEAPS?

A LEAPS can expire up to 3 years from the current expiration cycle date, making the option as an instrument, a viable longer-term trading strategy for investors (I use ‘longer’ loosely because its very subjective and based on an investor’s trading style – i.e. for a day trader, 3 years would be an eternity, but for a buy and hold style trader, it’s short-term). LEAPS added on additional expiration cycles to underlyings, extending the investing calendar from 1 to 3 years.

Where does that leave us?

After LEAPS were introduced, expiration cycles got quite a bit more complex. Like previously mentioned, it’s not necessary for you to understand the ins and outs of why expiration cycles occur at the frequency/times they occur at. With trading softwares, it’s no longer necessary to memorize or understand why certain underlyings have certain expiration cycles and other don’t. What’s most important is understanding what expiration cycle choices you have to make.

If you do want to know more about how the cycles currently work after to the addition of front month/back month and LEAPs cycles, investopedia does a great job breaking it down here.

Why Is Options Expiration So Important?

In the most basic sense, expiration is important because it sets a timeframe for your trade. Whether or not a trade is going in the right direction and how much time left until that option expires define what profit or loss you will incur as an investor.

This chart shows how time decay (theta) impacts the price of an option.

How many days you have left until an option expires is called days to expiration (DTE). During the time between the placement of the trade and the expiration date, a variable called theta (time decay), will determine if your trade is profitable or not. As the amount of time until your option expires – theta decay – decreases, this is favorable to the seller of the option, and not the buyer.

One last reason expiration is so important is due to its relation with stock assignment.

One fear that keeps some traders from placing their first options trade is the fear of being assigned stock (especially if you have a smaller account with funds less than that of what 100 shares of a stock would cost). Don’t let this fear stop you from placing your first options trade. It’s not that scary, I promise!

If you sell an option (naked or as part of another strategy – i.e. Iron condor) and that option is in the money when the option expires, you will be assigned stock. If you buy an option, you will never automatically be assigned stock. As the buyer, you always have the right, but not the obligation, to purchase the stock via the option you invested in.

How To Choose An Expiration Date

Choosing an expiration can be difficult, so here are some things to keep in mind when choosing an expiration date.

When picking an expiration date, your trading style should guide what expiration you choose. For example, if you day trade, you will probably always use the nearest expiration cycle. A premium seller may want to go farther out and find an expiration cycles with about 25-50 days to expiration, while someone who does technical analysis may adjust their DTE according to what their charts are telling them (which can vary from underlying to underlying).

Are you a premium seller (someone who sells options to collect premium)? tastytrade has done a ton of research into the mechanics of selling premium. After countless studies, the research team has found that you stand the best chance of profiting when you sell options with 25-50 days to expiration.

As mentioned before, most stock options have weekly, monthly, and quarterly cycles. Something to keep in mind when choosing an expiration date is what cycle the option is in, as this can have an impact on how liquid the underlying is. Weekly cycles tend to be less liquid than monthly/quarterly, so you may have a little trouble getting out of a trade in a weekly expiration cycle. Always keep liquidity in mind when choosing an expiration.

That may leave you wondering: why would you choose to invest in the weekly expirations if those options are generally more illiquid than monthly expirations?

There are several answers to that question, but the most popular are that weekly expirations would fit better in your strategy (if you invest in options that are between 1-10 trading DTE, then weekly expirations would provide you more opportunities to invest) and weekly expiration cycles are commonly used for earnings trades.

Earnings are another important consideration when determining an expiration date (along with dividends for similar reason). Earnings are a binary event, meaning that one of two outcomes can occur. the price can go up or down after earnings are announced and many times, earnings cause large swings in an underlying’s price and there is a corresponding ‘crush’ in the options volatility.

If you put a position on and there are earnings before that position expires, beware of the possibility of the changes in price caused by the earnings announcement. The amount that an underlying may go up/down after an earnings announcement is called the expected move. What the expected move does is quantify the potential move using statistics and historical data, ultimately giving you a price range that the underlying is expected to stay between.

Understanding Expirations On tastyworks’ Trade Page

Understanding the concept of expiration is one thing, knowing how to decipher it within a trading platform can be a whole new ballgame (due to shorthand terminology).

Anytime you set up a trade on tastyworks, you will need to pick an expiration cycle. One of easiest ways to do this is using the expiration buttons on the trade page pictured below.

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