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Options Expiration

Every 3rd Friday of the month is an expiration day on an options exchange, meaning that a number of options series expire on this day.

All those call options whose strike prices are higher than the price of the underlying stock or index will be worthless at the end of the expiration date. Those options series, on the other hand, whose strike prices are lower, will have some intrinsic value and may be exercised. The opposite applies, in the case of put options.

The options expiration date is the most important factor in calculating options prices:

• In order to price European style options, the Black Scholes model is used. The pricing is done by factoring in current stock prices, strike prices, time left until expiration, interest rates, any dividends, as well as the volatility of the underlying security.
  
• In order to price American style options the binomial model is used. The stock prices for various given time intervals within the expiration period, are calculated as a tree by the binomial model. The model determines how much a stock might increase or decrease in value by using the volatility of a stock and time left to expiration. All possible prices for a stock are calculated this way. Option prices are calculated using a risk neutral valuation , by working backwards from the expiration date to present. Fundamentally, each option is prices.

Option Style: There are American style and European style options. Options which can be exercised at any time up to the expiration date are the American style options. Options which can only be exercised on the date itself, are the European style Options.

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