Updated Feb 01, 2022

What is the futures and options contract expiry?

What is the futures and options contract expiry?

 

The expiry date, as the name implies, is the date on which a contract comes to an end. Every derivative contract that is based on an underlying security, such as a stock, commodity, or currency, has an expiration date, even if the underlying security does not.

 

A derivative contract based on an underlying security is only valid for a certain amount of time before it expires. The derivative contract is finally resolved between the buyer and seller on the expiry date. The settlement can take place in one of two ways:

 

Physical delivery: 

When the underlying security under a contract is physically delivered (as is frequently the case with commodities), the seller of the contract gives the quantity to the buyer, who pays the whole price.

 

Cash settlement: 

It refers to the settlement of the difference between the spot and derivative prices using money rather than the underlying security. In India, stock derivatives are currently paid in cash.

 

 

In the case of Indian stock exchanges, the contract expires on the last working Thursday of the month.

 

To fully appreciate the significance of this day on the trading calendar, you must be familiar with the details of derivatives expiry and settlement. This might assist you to understand how the expiration and settlement of the associated derivatives affect stock prices. So, let's begin by defining what derivatives expiration is all about.

 

 

What is derivatives expiry?

 

Derivatives expiry refers to the process of a derivatives contract's expiration. Every derivatives contract, as you may know, has an underlying asset that determines its value. A stock, money, or a commodity can be used as this asset. As a result, the underlying asset has no expiration date. However, the derivatives contract based on that asset has an expiration date.

 

A derivative is no longer valid once it has expired. As a result, all derivative contracts must be completed on or before their expiration date. The derivatives expiry date is the date by which the contracts must be fulfilled in the future.

 

Now, as a curious trader, it's probably difficult to keep track of when certain derivatives expire, right? This is especially true when dealing with various sorts of derivative contracts. The expiry of derivatives in the Indian market has been set to the last Thursday of the month to make things easier for traders. If the last Thursday happens to be a trading holiday, the prior trading day is used as the month's expiration date.

 

In the market for derivatives, you will typically find three contracts with varying expiry dates. These are the following:

 

• The near-month contract
• The next month contract 
• The far monthly contract

 

The current month's 'near month contract' expires on the penultimate Thursday. The 'next month contract' is valid until the final Thursday of the next month. And the 'far month contract' is set to expire on the third month last Thursday.

 

Let's pretend you're now in August 2021. Take a look at the Nifty 50 futures contracts with the following expiration dates.

• August 26, 2021: Near month contract
• September 30, 2021: Next month contract
• October 28, 2021: Far month contract.

 

 

What exactly happens on this day?

 

Futures and Options are the two types of derivatives contracts traded on the market. Traders purchase these contracts to buy or sell the underlying assets at a specified price at a future date. The derivatives expiry date is this day in the future. Futures contract buyers must meet the agreement on this day, whereas options contract buyers can choose to execute the terms or let the contract expire.

 

 

Why is it the most significant day of the year?

 

When a trader buys a derivatives contract, they keep an eye on the underlying asset's movement on the stock markets, as well as other factors such as open interest, future price movement, and so on. They decide when to square off or settle the contracts, based on their observations. This can be done at any moment before the expiration date.

 

A settlement is the completion of a derivatives contract agreement. A settlement value is a price at which each contract is settled. This value is frequently determined by the closing price of the underlying asset on the last day of the series, which could be a stock, index, commodity, or currency in the cash sector.

 

Contracts that have not been settled by traders voluntarily expire on the expiration date. The trader must pay or receive the settlement value in cash in the case of futures and in-the-money options contracts, while out-of-the-money options contracts become null and void.

 

Returning to the movie example, traders can take new positions in options or roll over futures contracts in the following series if they perceive promise in a particular contract. This is normally decided on an expiry date based on the previous month's rollover data.

 

 

Option Value and Expiration

 

The more time a stock has till it expires, the more time it has to reach its strike price, and hence the more time value it has.

 

Calls and puts are the two forms of options. Calls provide the holder the option to buy a stock if it reaches a specified strike price by the expiration date, but not the responsibility to do so. Puts provide the holder the option to sell a stock if it reaches a specified strike price by the expiration date, but not the duty to do so.

 

This is why, for options traders, the expiration date is so crucial. The concept of time lies at the center of what determines the value of alternatives. Time value does not exist after the put or call expires. In other words, after the derivative has expired, the investor loses all rights associated with the call or put.

 

 

Futures Value and Expiration

 

Futures vary from options in that even a losing futures contract (loss position) retains its value after expiration. An oil contract, for example, represents barrels of oil. If a trader retains a contract until it expires, it is because they want to buy (they bought the contract) or sell (they sold the contract) the oil represented by the contract. As a result, the futures contract does not expire worthlessly, and the parties are obligated to each other to fulfill their contractual obligations. Those who do not wish to be held responsible for the contract's fulfilment must roll or close their positions before the last trading day.

 

To collect their profit or loss, futures traders must close the contract on or before the expiration date, sometimes known as the "last trading day." They can also keep the contract and have their broker buy or sell the underlying asset the contract represents. This isn't something that most retail merchants do, but it is something that businesses do. For example, an oil producer who sells oil through futures contracts may choose to sell its tanker. Traders in the future can "roll" their positions. This entails closing their present transaction and immediately reopening it in a contract with a longer expiration date.

 

 

Bringing things to a close

 

The expiration date of a derivative is the last day on which it is valid. The contract will end when that period has passed. The expiration date can have a variety of effects depending on the type of derivative.

 

Owners of options can either exercise the option (and profit or lose money) or let it expire worthless.

 

Owners of futures contracts have the option of rolling their contract over to a later date or closing their position and taking delivery of the asset or commodity.