Expiry Strategies That You Should Know
The stock market offers various ways for traders to make money and one of the popular approaches used by traders includes expiry strategies. The day a derivatives contract expires is known as expiry day. As the date of expiry comes closer, there is a significant increase in trading activity as traders try to use expiry strategies to make profits. Expiry day is also known as the last trading day for the contract. In case of option contracts, traders can choose to either exercise the option or let the contract expire in a worthless manner, depending on the market scenario. Therefore, the expiry date is also the day on which the options contract becomes invalid. Different securities may have diverse expiry dates, based on the principles in the contract and traders using expiry strategies need to maintain a calendar to stay abreast of upcoming expiration dates.
Expiry strategies revolve around the fact that, as the date of maturity approaches, the volatility in prices increase steadily. Expiry days see strong trading activity as all cash-settled futures and options are closed at the settlement price or rolled over to the next expiry contract. The underlying volatility during this period offers traders strong potential to realise gains from day trading as there are sharp fluctuations in prices. Usually, the price of the security tends to move towards the strike price, causing a large chunk of options contracts to expire in a worthless manner. This is also known as the theory of maximum pain as it prevents the trader from realising profits based on their earlier speculations.
Expiry Strategies You Should Know
Market participants usually trade options near the expiration date with the aim of making money and closing profitable positions. They may also close out positions that are deep in the money because, with the expiration date nearing, the underlying risk grows significantly. While there are various expiry strategies that traders employ to make money, the most popular ones include the following –
- Option buying at expiry date – Considered one of the most common expiry strategies, this approach involves buying options with multiple strike prices. Traders who choose this strategy benefit from the increased likelihood of the price moving in their favor and exercise the option before expiry.
- Option selling at expiry date – In this strategy, traders sell multiple options near strike prices in an attempt to collect as much premium as they can. They sell out of the money options in the belief that these will expire worthlessly, earning them profit from the premiums.
- Bear and bull call spread – These strategies involve buying one at the money option and simultaneously selling one out of the money options contract at either the intraday top or intraday bottom. If you follow the bear approach, you can profit when the price of the underlying security drops and vice versa for the bull spread approach.
- Options Gamma Trading – Option contracts at expiration are driven by the gamma factor which measures the underlying risk in the security. In simple terms, the gamma factor helps traders answer the question of how much the option price will fluctuate if the stock price moves by a dollar. In the expiration period, the gamma factor is known to rise significantly and experienced traders can use this strategy to realise gains from options trading as well as from the increased volatility.
- Friday Expiration Straddle Strategy – This expiry strategy can come in handy if you expect either a big movement or no big movement on expiry day. It involves a neutral approach which consists of purchasing or selling a put option and a call option simultaneously, at the same strike price and with the same date of expiry. This strategy can be beneficial as it has the potential to offer you high rewards if your speculation pays off, that too with a small investment when you are a buyer of straddle. However, this movement is only feasible if you expect the market to move sharply in either direction.
Expiry strategies can be employed in all types of markets to realise strong gains. However, as the market is filled with uncertainty, you need to know how to make volatility your friend if you wish to benefit from expiry strategies. It can be an exceptionally risky endeavor if you are not well-versed with the market or fully aware of the underlying risks. If your speculation ends up being wrong and you do not have a hedge in place, you may end up losing a lot of money.
Expiry strategies are a great way to earn money in all types of markets, as long as you have adequate knowledge of the market, a high risk appetite and the time to track the market consistently. It is advisable to begin your expiry strategy trading journey with limited risk positions to better understand your aptitude for the approach. Once you know where you stand and find it easier to make decisions, you can place bigger bets and earn robust returns using expiry strategies.
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