What is expiry day trading?

‘Expiry’ in the stock market refers to a contract running into its expiration date. This is a term that’s usually used in derivatives trading. In the Indian stock market, derivatives are mostly of two types – futures & options.

The expiry day trading strategy is usually used in NIFTY options trading – also known as index options trading. While this strategy, if implemented correctly, could give massive returns, it comes with a lot of risks as well. Wer’e going to cover both the advantages and risks of expiry day option trading in this article.

What is the expiry day trading strategy?

All options have an expiry date – the date after which they can’t be traded on the market anymore. Expiry day trading refers to trading strategies that are executed on this expiry date of your contract.

On this day, traders have two options – either exercise their options or let them expire worthless at the end of the day. Expiry days usually fall on the last Thursday of the month for monthly options contracts.

Like we said earlier, this is an extremely high-risk, high-reward strategy of trading. While the buyer of the options contract can very well exit the contract before the expiry date, the strategy works only when they decide to stay invested till the last day.

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Understanding the strategy

Here’s a breakdown of everything you need to know on expiry day:

• In The Money (ITM) – This goes in two scenarios: either you have a put option to sell above the current market price, or a call option to buy below the current market price.
  In both these cases, you’re in the money and your contract has ‘intrinsic’ value, which is to say that it’s profitable for you to either exercise the option or to sell it. In either case, you make money.
• Out of the Money (OTM) – If you’re on the opposite end, however (meaning you have a put option below the market price or a call option above) it’s usually not profitable to exercise your option. Traders usually let these options expire worthless.

What to do on expiry day

Expiry day trading basically entails making the decision whether to sell, buy, or exercise the option you have on expiry day. These decisions are made based on market conditions and your risk appetite:

• The short straddle – In straddle strategy, traders sell both a call and a put option with the same strike price and expiry date. This way, they profit from the lack of movement in the asset. The options expire without exercise and the selling premiums become profit.
• Short strangle – Here, the trader sells both a call and put option with the same expiration dates but with different strike prices. Here too, the trader profits from the stability of the underlying asset.
• The iron condor – This is a bit more complicated. In the iron condor strategy, the trader sells both call and put options with the same expiry date but at different strike prices.
  Like above, the trader gets to keep the options premium if price remains relatively stable. However, the trader also buys OTM call and put options as hedges. This way, of the price remains relatively stable, the trader profits from the premiums.
  However, if prices become volatile and cross the sell strike price, the hedge call and put options work to minimise losses.

Also read: What is the strangle option strategy?

How to Trade Options on Expiry Day

Expiry day for options is a crucial day for traders, as it marks the last chance to exercise or close options contracts before they become worthless. On this day, markets can experience heightened volatility, and traders need to be strategic in their approach. Here’s a breakdown of how to trade options on expiry day:

1. Monitor Market Trends: Keep an eye on the overall market sentiment and price movements leading up to expiry. Market trends and economic events could have a significant impact on how the options behave on expiry day.
2. Understand Time Decay: As expiry approaches, options lose value rapidly due to time decay (theta). This is particularly important for out-of-the-money options, which could become worthless by the end of the day.
3. Focus on Liquidity: On expiry day, the liquidity of options contracts can increase, especially for the near-the-money strike prices. This gives traders better opportunities to enter or exit positions.
4. Set Exit Plans: Have a clear exit strategy, whether you’re planning to take profits or minimize losses. With options expiring, you don’t have the luxury of holding the position beyond the expiry.
5. Be Cautious with Out-of-the-Money Options: If you are holding out-of-the-money options, expiry day can be risky. They might expire worthless, so ensure you assess whether the underlying asset has any chance of reaching the strike price before the market closes.

Impact of Expiry Day on Market Volatility

Expiry day has a significant impact on market volatility, especially in options-heavy markets. Here’s how:

1. Increased Volume and Liquidity: As traders rush to exercise or close their positions, there is usually a spike in trading volume. This often results in increased volatility, especially in the final hours leading up to the market’s close.
2. Gamma and Delta Effects: As options near expiration, their gamma (rate of change of delta) increases. This can lead to larger price movements in the underlying asset as the options market-makers adjust their hedging strategies. Traders should be aware of the potential for sharp moves in the underlying asset, especially in stocks or indices with high open interest in options.
3. Pinning Effect: In some cases, stocks or indices may exhibit a phenomenon known as “pinning,” where the underlying asset’s price gravitates toward a strike price with heavy open interest. This often occurs on expiry days as the market settles near a significant strike price.
4. Market Reactions to Expiry: The final few hours of expiry day often witness a flurry of activity as traders look to close or roll their positions. This can lead to more erratic price movements, as traders react to the expiration of contracts.

Effective Option Buying and Selling Strategy for Expiry Day

On expiry day, the strategy you use for buying and selling options should be adapted to the unique dynamics of the market. Here are a few strategies to consider:

1. Scalping for Small Gains: Since options can be volatile on expiry day, short-term traders often use scalping strategies to take advantage of price movements. This involves entering and exiting positions quickly, looking to make small profits on rapid price swings. Scalping works best when liquidity is high, and market movements are expected to be quick and erratic.

2. Selling Options Near Expiry: If you’re confident that the underlying asset will not reach your strike price by expiry, selling out-of-the-money options can be a profitable strategy. As expiry nears, the time value of options decays rapidly, allowing sellers to profit from time decay. However, this strategy carries significant risk if the market moves sharply against your position.

3. Buying In-the-Money Options: For those looking for a more direct approach, buying in-the-money (ITM) options can be an effective strategy on expiry day. ITM options are more sensitive to the movements in the underlying asset, providing more leverage as expiry approaches. Be aware, however, that ITM options can still experience significant price fluctuations due to increased market volatility on expiry day.

4. Straddle or Strangle: A straddle (buying a call and a put at the same strike price) or strangle (buying a call and a put at different strike prices) can be an effective strategy when expecting large price moves on expiry day, especially if you anticipate volatility. These strategies allow you to profit from significant moves in either direction. However, they are best used in situations with high implied volatility.

5. Rolling Over Expiring Positions: If you still believe in your original trade idea but want to avoid expiry day risk, you can roll over your position by closing out the expiring option and opening a new one with a later expiration date. This strategy allows you to maintain your exposure while avoiding the risks associated with holding options on expiry day.

Benefits of Buying Options on Expiry Day

While expiry day can be volatile and unpredictable, there are several advantages to buying options on this day:

1. Cheap Premiums Due to Time Decay: As expiry approaches, the time value of options decreases rapidly, which means options become cheaper to buy. If you anticipate a sharp move in the underlying asset, buying options on expiry day allows you to take advantage of lower premiums while maintaining upside potential.

2. Increased Liquidity: On expiry day, options with close expiration dates often see increased trading volume and liquidity. This makes it easier to enter or exit positions, especially in the final hours of trading, which is advantageous for active traders looking to capitalize on short-term movements.

3. Potential for Large Price Moves: Expiry day often brings increased volatility, as traders close their positions or hedge their portfolios. If you expect the underlying asset to move significantly, buying options on expiry day could yield high rewards with relatively low upfront cost, due to the time decay.

4. Opportunity for Leverage: Since options on expiry day are typically cheaper due to time decay, they offer more leverage compared to longer-dated options. This can be beneficial if you’re anticipating a significant price movement but don’t want to commit as much capital.

Also read: Do all technical analysis tools work equally well?

Conclusion

Expiry day trading, in conclusion, is trading option contracts on the date of their expiry. There are two options there – either exercise the option or let it expire worthless.

However, this trading strategy is risky because the contracts have little to no theta (time value), meaning if something were to go wrong at the last minute, your stop-loss is the only hope.

We encourage you to do your own research and paper trade before you trade your options with this strategy. Until then, good luck!