Expiry in Derivatives

As the name suggests, the Expiry date is the date on which a particular contract (usually a derivative contract) expiry. Every derivative contract based on an underlying security such as a stock, commodity, or currency has an expiry date, i.e. it exists only for a specified period.

In the Indian Stock Market, the expiry date of Index and Stock derivative contracts is on the last Thursday of every month, and in case that Thursday is a holiday, it will be one day earlier on Wednesday.

Expiry in Derivatives

Expiry is a term used for derivatives - future and options settlements. Normal traders and delivery holders don’t need to worry too much unless they hold some highly volatile stock. Traders review their derivatives holdings a few days or a week before expiry to check if it is rewarding or not. On or before this day, investors will have already decided what to do with their expiring position. Generally, these traders frequently hold stock in both the secondary stock and derivatives market.

What happens on the expiry date?

On the expiry day, the contracts are settled between the buyer and seller. It can be carried out in two ways: you can buy another contract that nullifies your current contract or settle in cash.

On this day, the derivative contract finally gets settled between the buyer and seller which can happen in either of the following ways:

Physical delivery

In the case of physical delivery of the underlying security under a contract, the seller of the contract delivers the quantity to the buyer, who pays the full price for it.

Cash settlement

In the case of physical delivery, the difference between the spot price and the derivative price is settled in cash. Currently, equity derivatives settlements are carried in cash.

What happens to the contract after expiry?

After expiry, the contracts become invalid and cannot be enforced. Every expiry day entails settlement of all contracts at the settlement price which is already derived 30 minutes before so that no one can manipulate the closing price. Contracts are adjusted on the day they expire (or in the case of Options, they basically expire). The trader can either buy another contract that eliminates their current one or pay off in cash.

Futures and Options contracts

Derivatives that are traded on the exchange are of two types - Futures and Options. The contract buyer agrees to buy or sell the underlying assets (stocks, in this case) at a fixed price at a future date. In a futures contract, the buyer has to fulfill the agreement without having an option otherwise. Whereas in an Options contract, the buyer doesn’t have an obligation to fulfill the terms of the agreement.

The main purpose of a commodity futures contract is to exchange the underlying security for cash at some future date. Many futures contracts are not held until expiry. Instead, traders make money by the price changes in the futures contracts. And hence, most short-term traders exit their futures positions without waiting for them to expire. If the trader wants to maintain their position without having to exit, they can place a trade in another futures contract with an expiry date that is not near.

Unlike a stock, each options contract has a set expiration date. Options Expiry generally refers to the last date of an option contract. Before an option expires, its owners can choose to exercise the option, close the position to realize their profit or loss or let the contract expire worthless. The option holders cannot exercise their right according to the terms after expiry, (the last date till which an option is valid). When you hold a long position in an option (Buy) and the option expires worthless, you lose the whole amount of money used in buying that option.

How does Expiry Affect Stock Prices?

Futures and Options contracts derive their value from their underlying stocks or indices. Nevertheless, over short term, the derivatives contracts can also affect the stock prices.

When the investors become optimistic about the near future. So, the volume 'Buy' contracts increase in the derivatives market in comparison with the 'Sell' contracts. And by looking at this, the investors in the cash market might start buying the shares in anticipation of higher profits soon. And when the buying increases in large quantity, the stock price actually rises.

Contracts do not last forever. They expire or terminate; they all have an ending date. It is advisable to monitor a contract based on the previous month’s data and analysis, if you find it potentially profitable, you can take fresh positions in options and if not you can rollover futures contracts.