In short:
An expiration date in futures and options (called derivatives) is the last day a futures or options contract is valid. On the expiration date, the contract will be settled between buyer and seller. It is important that the investor holding an expiring contract has decided what to do with their position before expiration.
Key Points
- The expiration date of derivatives contracts represents the ending date of the contract. After this date, the contract is no longer valid.
- For options, the expiration day is the last day the option owner can exercise the option before it expires worthless.
- For futures, the expiration day is the last day the futures portion of a contract is valid, after which, contract owners will be subject to buying or selling the physical underlying asset.
In-depth:
What are Derivatives
The term derivative in financial markets simply means a financial instrument gets its value based off the value of another asset. Without being tied to the value of another asset, derivatives have no value in and of themselves.
Derivatives represent some claim to an asset but only for a certain period of time. For this reason, derivative traders must know when the expiration date of a derivative is as that represents the end to the claim.
Additionally, derivatives are a form of leveraged investment. This means that they allow the derivative owner to have some form of claim over a large amount of assets with only a small amount of capital.
Expiration and Options
The main source of value for options comes from their time value. That is, when you own an option, you’re buying a claim to the underlying asset for a period of time. The more time there is until expiration, the more time there is for the underlying asset to reach the strike price and thus the more value it has.
This is why the expiration date for options is important. The time until expiration determines most of the value of an option. After expiration, the option no longer has any value and the option owner no longer has any rights to the underlying asset.
There are two types of options, calls and puts. Call options provide the right to buy the underlying asset at a certain price within a certain timeframe but not the obligation. Puts, on the other hand, provide the right to sell the underlying asset at a certain price within a certain timeframe but not the obligation.
Key idea, unexercised options contracts are worthless after expiration and the more time to expiration the more value the option has.
Expiration and Futures
Futures contracts are different from options in quite a few ways with the expiration date being no exception. This is because when a futures contract expires it still holds value as a futures contract represents the underlying asset.
For example, a soybean contract represents 5,000 bushels of soybeans. Holding a soybean contract into expiration either means you want to buy or sell the 5,000 bushels of soybeans the contract represents. As such, the contract has value after expiration and each party must fulfill their end of the contract.
It is important to note many futures contracts are physically settled to enforce convergence. This means that holding a soybeans futures contract through expiration will make you liable to make or take delivery of 5,000 bushels of physical soybeans.
To avoid being liable for the underlying asset at expiration (called assignment), traders must close or roll their position. This will allow traders to purely focus on the direction of the underlying assets price and establish or continue a position.
Key idea, futures contracts held through expiration are subject to assignment which may include physical settlement of the underlying asset -i.e. futures are not worthless after expiration.