Trading options gives you the right to buy or sell the underlying security before the option expires. The closer an option gets to its expiration day, the faster it loses value. Weekly options expire every Friday and monthly options expire the third Friday of each month.
Option trading can be volatile and unpredictable on expiration day. You can protect your trading account by avoiding some of the more common mistakes option traders make.
One of the most common mistakes traders make with options is forgetting when these contracts expire. Depending upon the specific type of options contract you have purchased, rules regarding expiration will differ.
Close Your Trade Before Expiration
You opened your option position to make a profit and now your options are set to expire. If you have a profit, you may be tempted to keep the trade open on expiration day to get a little more money. If you have a loss, you may want to try to get some of your money back.
The reality is that the closer options get to expiration, the faster they lose their value. The odds of making a few more bucks are against you. To protect your trading capital, close out your option trades and take your profit or loss before your options expire.
Avoid Your Broker’s Margin Call
If you own one call option with a 50-strike price and the stock closes at $50.03, your option is automatically exercised; come Monday morning, you now own 100 shares of stock. You will get a margin call from your broker if you do not have enough money in your account to pay for the stock.
In that case, you must sell the stock to close out the trade. If the stock sells below the exercise price, the loss comes out of your trading account. You can avoid this mistake by closing out your open option positions before the market closes on expiration day.
Avoid Options to Buy Stock
Buying call options with the goal of owning the stock when the options expire is counterproductive. You buy call options to make money when the stock price rises. If your call options expire in the money, you end up paying a higher price to purchase the stock than what you would have paid if you had bought the stock outright.
You are also out the commission you paid to buy the option and the option's premium cost. If you really must have the stock, buy it outright to avoid unnecessary costs and fees.
Know When European-Style Options Expire
Even seasoned traders can forget that European-style options expire on the third Thursday of the month instead of on the third Friday, as American options do. If your strategy calls for closing out your European option trade on expiration day and you forget about this time difference, your Europeans options will expire before you realize it. This could result in heavy financial losses for some traders.
You will not know if your option expired in or out of the money until late Friday morning or early afternoon when the settlement price is determined. Avoid this mistake by remembering to close out your European option trades on Thursday before they expire on Friday. When in doubt, create some sort of reminder or alert to help ensure that you don't forget these expiration dates.
Based in St. Petersburg, Fla., Karen Rogers covers the financial markets for several online publications. She received a bachelor's degree in business administration from the University of South Florida.