Understanding Option Premiums at Expiry: Call and Put Buyer and Seller

When it comes to options, the question often arises, 'Do the premiums of call and put buyers and sellers become zero at the time of expiry?' This article delves into the nuances of option expirations, providing a comprehensive insight into what happens to the premiums of call and put options as their expiry nears.

Understanding Options: In-the-Money (ITM) and Out-of-the-Money (OTM)

Before we dive into the specifics of option expiry, it's crucial to understand the basics of in-the-money (ITM) and out-of-the-money (OTM) options.

For a call option, the strike price is lower than the current stock price, and for a put option, the strike price is higher than the current stock price. ITM options have an intrinsic value, which is the difference between the strike price and the current stock price. OTM options, on the other hand, have no intrinsic value and are often discarded by buyers at expiration.

What Happens to Option Premiums at Expiry?

As we approach the expiry date, the options market undergoes significant changes. Extrinsic value, which is the part of the premium that compensates for the time value of the option, gradually diminishes and eventually becomes zero. This is why we often hear that option premiums generally become zero at the time of expiry.

Out-of-the-Money (OTM) Options at Expiry

OTM options, whether they are calls or puts, usually have an expiry value of zero. If a call option is out-of-the-money and the underlying stock price is at 499.99, and the strike price is 500, the call option is worthless. Similarly, if a put option is out-of-the-money and the underlying stock is trading above the strike price, it will also expire worthless.

In-the-Money (ITM) Options at Expiry

ITM options, which have intrinsic value, retain that value until expiry. If a call option with a strike price of 500 is in-the-money and the underlying stock priced at 501, the option will be exercised, and its value will be 1. However, asexpiry approaches, the time value component of the premium often becomes negligible, leading to the option being priced at or near the intrinsic value.

Factors Influencing Post-Expire Premiums

However, there are some factors that can influence the post-expire premium, even if options are typically priced at zero post-expiration:

Liquidity and Minimum Tick Prices

Due to liquidity constraints and minimum tick prices, options may trade at a minimum price, often 0.01 or 0.05, which can be higher than their intrinsic value or even zero. This is especially true for in-the-money options, as traders might choose to close the position for a profit, rather than exercising the option.

After-Market Exposure and Overnight Risk

Options can have additional premiums attributed to after-market exposure. This means that the underlying stock price can fluctuate after the market closes, impacting the decision to exercise or close the position. This can create a risk for traders who are not aware of such fluctuations, especially near the expiry date.

Extended Trading Period

There are instances where the premium may not fully disappear until the extended trading period ends, which occurs after the market has closed. This can be attributed to market conditions that allow for some premium to remain.

Conclusion

In conclusion, as we approach the expiry of options, the premiums of both call and put buyers and sellers tend to approach zero. This is because the time value inherent in the premium diminishes, and the options either become exercised (in the case of ITM) or expire worthless (in the case of OTM).

However, it is important for traders to be aware of factors like liquidity constraints, minimum tick prices, and after-market exposure, which can influence the final value of options. Proper knowledge and planning can help in minimizing risk and maximizing returns.

Remember, while option premiums often become zero at expiry, there can be exceptions due to the complexities of the market and the specific conditions of each trade.