Expiry Day Trading

Expiry day trading is a financial term used by derivatives traders to trade the F&O contracts on the date of expiry. It allows them to square off their position and make profits, if possible, on the last day. Traders implement strategies that aim to capitalize on the market volatility that drives the contracts on the expiry. As a result, there are some chances of retaining the contract's value later as well. In short, the sole aim of the trader is to quickly sell the option contract by accurately predicting the price movements.

The working of an expiry trading moves parallel with the options trading. At the same time, most traders enter futures and options to benefit from quick market movements and the chances of profit staying. They tend to buy the contract at a lower premium with the assumption of making higher returns. Traders take advantage of time sensitivity so as not to lose value on the last day. However, similar monitoring is necessary to look at the price movements as small price changes can largely impact expiry trading strategies. Nonetheless, understanding the nature of the options and assessing risk ensures the timely execution of contracts on expiry day. 

The concept of equity option trading dates back to the late 19th century. However, the increased participation in all expiry day trading occurred after the COVID-19 pandemic. It allowed a certain level of opportunities for traders to sell above the strike price or buy below the market price.

Let us look at the expiry day trading list of strategies that are implemented mainly by traders in derivatives trading:

Short straddle

It refers to the trading strategy of selling both calls and put options with the same expiry at an identical strike price. Traders use this technique when they feel the underlying asset's price will stay stable for a long time. However, they also assume that the price may fluctuate by a very small percentage. They benefit from the premiums received from selling the options by implementing them during the expiry day trading time.

Short strangle

A short strangle is a delta-neutral strategy of selling a call with a higher strike price and a put option with a lower price. On the expiry day, the call price of the option must be above the put strike price. However, the chances of booking profits through premiums are possible if the contracts are held until expiry.

Bear put spread

Among such strategies, this one allows traders to buy a put with a higher strike price and, likewise, sell a call option at a lower price. However, the expiration date and the underlying asset remain the same. Here, the chances of profits stay when the underlying asset's price drops below the strike price on expiry.

Let us look at the real and hypothetical examples of such trading to understand the concept better:

Example #1

Suppose James is a trader who often trades in option contracts for the past seven years. He has made a portfolio with the most profitable stocks in this period. However, most of them were derivatives contracts. Recently, James bought a buy option for the S&P (Standards and Poors) 500 index with a strike price of $4500, which was meant to expire on October 31st. Similarly, he also took a put option of the same strike price and expiry. 

At this point, James decides to execute a strategy where both options stay in the money (ITM). He sold the put option above the strike price (at $4800) and bought the call option at a lower price ($4300). Here, clearly, there is a whooping profit of $300 + $200 = $500. In contrast, if James had applied the out-of-the-money (OTM) strategy, the options would have expired worthless.

Example #2

As per an article published on September 15, 2023, $5.5 trillion in options expire on triple witching Friday. This term refers to the simultaneous expiration of stock options, index futures, and index options. This phenomenon happens four times a year and often leads to heightened market volatility. The article highlights the possible huge price swings this could have on equities like Nvidia. This is an essential event for traders due to the large number of expiring contracts. It presents a pivotal moment to manage risks and expectations in the market.

Market volatility is uniform to all financial instruments tradable in the market. And expiry plays a pivotal role in balancing the volatility to a significant extent. The closer the expiry is, the higher the fluctuation rate is. However, when considering expiry day trading time, the influence occurs on some factors as well. Let us look at them:

Position squaring

One of the common effects of expiry is visible in the trader's behavior. When expiry is near, most traders try to square their position to squeeze some value from the option contract. This sudden selling and buying of options can create a FOMO or panic situation in the market.

Change in delta

Generally, option sellers tend to use a delta hedging strategy to mitigate risk in derivatives. This strategy involves buying and selling options simultaneously to maintain a neutral position in the market. As expiry approaches, delta experiences a huge fluctuation that impacts the hedging transactions. Likewise, when traders apply both squaring and delta hedging techniques, trading volume increases.

Market events

Events and news around the expiry date have the most influence on volatility. At this time, the market is susceptible to news and can cause uneven fluctuations. As a result, traders may react in the same way, which may cause more chaos in the market. 

Such trading has been a vital concept to the derivative traders. Let us understand how it serves as a significant aspect to them in brief: 

• Settlement is of the utmost importance during contract expiry. For buyers, exercising their right or letting it expire is an option. However, sellers must fulfill the obligation anyway.
• As time passes, the concept of time decay also surfaces. This leads to a decrease in the time value of the option contract, which in turn significantly impacts the option prices. 
• Additionally, all these events lead to rising market volatility, which increases trade volume and causes random fluctuations in the prices of underlying assets. 

Traders can assess the risk levels on the last trading day to minimize unexpected losses. This allows them to make more informed decisions and avoid significant fluctuations in their portfolios.