We have seen many strategies for trading options in the Indian stock market. We have also seen what type of analysis a trader should do before entering into the options, and that is fundamental analysis and technical analysis. Options trading provides the opportunity to make a profit in all market situations, but on the day of an option expiring, you should be extra careful.
On Options Expiration Day, the traders have to go through the dilemma of whether to execute the contract or stay in the current position. There are always choices to make: buy or sell the option contract. It depends on if buying or selling is profitable, are your trading goals fulfilled? etc. In any situation, there are certain things you must avoid on the expiry date or on the last Thursday of every month.
We are listing some of the traps traders must avoid during this highly volatile period. We shall also provide some pro tips to help you manage any unseen or crazy market position.
Let us move forward and see what those traps are that can affect the trader's profit and may turn the whole game upside down.
1. Do not execute the long option from your bucket:
You should try to avoid Exercising the long option available in your bucket at the expiry time. If you are not a huge fan of that company's stock, you should not consider exercising the options contract during expiry. If you exercise the options, you will need to pay the additional.
2. Check your option’s style- are they European or American?
In most cases, the traders prefer to trade in an American style, but some prefer European-style options. So, make sure you are aware of the difference between them before exercising the contracts. Let us make you clear on the meaning of both styles.
European style: European style execution means Option Buyers can exercise their options contracts only on Options Expiration Day.
American-style contracts are those that can be exercised any time before the expiry date. This is only for exercising; it does not mean that the option sellers or buyers are stuck in the situation.
Please also understand when the trading stops for American and European-style contracts to avoid more confusion. When you approach the Options Expiration Day, the American-style contracts cease trading on the last Wednesday of the month though there are some exceptions. While on the other hand, the European index option contracts stop trading the day before the expiry.
The settlement price of the European style is not like that of the American. The early price of the Last Friday of the month is taken for calculations, and generally, during this time frame, the prices are in-the-money. So, if you have decided to exit from the trade, it would be better to exit on Thursday afternoon while dealing in European-style options.
3. Don't hold on to the position till the last minute!
We all know how it feels in the exam hall to hand over the answer sheet, in the end, thinking, let me write 2 more lines to gain some extra marks. The same thing does not apply here.
It's hard sometimes to let things go. There can be two outcomes here; one is; you are already losing on your trade but still think that the market may turn in your favour and you will make some money at the end of the day. The second outcome may be that you have already earned a profit and are unsatisfied with it and want to stay in the trade to make more profit. In both cases holding your position is not worth it. Kindly remember the last few days of the Expiration Month are the worst time to exit from the trade as the Gamma risk is very high. The Gamma risk means the underlying asset's price can swing up and down at a faster pace. In such huge price movements, there are chances to lose all your profit overnight.
In case you are an option seller, let the option expire worthlessly. For some traders, the expiry time is the best as they allow option contracts to expire worthlessly and keep the premium collected.
4. Checking on open interest
Many traders forget to check on some important parameters which they must check. One such parameter is open interest. The open interest table represents the number of open contracts for the call and put options. The main reason to check open interest is to identify the strike price at the expiry date. The more overlap the value is in the open interest table, the more likely the chances are that the market will bend towards that price level at the time of expiry. You must also remember that open interest and volume are not the same things; they are different.
Pro Tips to avoid the dilemma at the expiry period:
As the options come with an expiry, few traders believe in refraining from trading in options, and according to them, trading in shares and earning profit from the single dimension is the best way. Well, it depends on the individual perspective of viewing trading activities.
In options, you may take advantage of your winning position before the expiration if the position is in your favour. There is a unique technique or strategy called rolling. As the name suggests, lock your profit and move upwards to get more profit. Rolling can be done at the time of expiry or any time before the expiry. Receiving benefits earlier is more advantageous than waiting.
With the help of the rolling technique, you can take your profit and reinvest your original investment for buying the other options contracts. Suppose the price rises and you have a call option; then roll up your contract to a higher strike price to get more profit. On the contrary, if you have a put option, roll -down the strike price to get maximum profit.
By using this technique, you will be able to limit the risk associated with your position and, most importantly, gain higher profits. This type of advantage is only available in the options market, which is why options are getting more attention.
So, on this page, you learnt the traps you should avoid during the options expiration month. As promised in the beginning, we also stated the pro tip to get higher profit. If your options contracts are about to expire and you need assistance, do not hesitate to leave a comment below. Our options expert team will ensure that your query gets resolved at its earliest.