You must’ve heard the term “expiry” when it comes to derivatives like futures and options contracts. In fact, expiry is such a crucial concept that every derivative trader looks forward to it while online trading.
The question is – what is expiry in stock market and why is it so important? The answer is simple but first, you need to know what a derivative contract is in detail.
Basics of a Derivative Contract
A derivative contract is a financial instrument whose value is derived from the value of the underlying security. These underlying securities can be either stocks, commodities, or currencies.
While there are several types of derivative contracts, the most popular ones are exchange-traded derivatives like futures and options contracts.
Much like any other contract, futures & options contracts are an agreement between two parties – a buyer and a seller. But the key difference lies in the structure of futures and options.
- Futures: the right and obligation of buying/selling the underlying securities on expiry
- Options: the right but not an obligation of buying/selling the underlying securities on expiry
The settlement between both parties happens at a specific price, within a specific period, and comes with an expiration date, which is known as expiry in the stock market.
Meaning of Expiry in Stock Market
The expiry date in stock market is the day on which the buyer and the seller must fulfill their end of the agreement as a part of the derivative contract, irrespective of the profit or loss incurred.
In other words, the futures or options contract becomes worthless after expiry. Of course, most traders are known to square off their positions on or before the expiry date so that they do not have to exercise the derivative.
You could, thus, say that expiry in stock market is a finish line, after which:
- The futures or options contract may be settled either in cash or physically
- A trader must fulfill their end of the contract (if their position isn’t squared off)
- The contract may become worthless on expiry
The race to the finish line is often exciting and leads to above-average volatility and trading activity on stock exchanges. That’s why it is important to know stock, commodity, and forex market hours in India.
List of Futures and Options Expiry Days
There are similarities in the way futures and options contracts expire. But you must know two key terms before we move forward:
1. Monthly expiry
2. Weekly expiry
Monthly expiry is applicable for futures and options. Weekly expiry is applicable only for options. Monthly contracts are available for the current month, the next month, and the month after. These are termed as:
- Near Month Contracts
- Next Month Contracts
- Far Month Contracts
All monthly futures and options contracts expire on the last Thursday of the month. If the last Thursday is a stock market holiday, the preceding Wednesday serves as the expiry date. Except, Finnifty Index and Nifty Midcap Select Index options expire on the last Tuesday of the month.
Weekly expiry is interesting. It is, as you know now, applicable only for options contracts. The weekly expiry is set for Thursdays except for Finnifty Index and Nifty Midcap Select Index options which expire on Tuesdays.
What Happens to F&O Contracts on Expiry?
Most f&o traders prefer cash settlement where there’s no exchange of the underlying but just a profit or less exchange. If we are to assume that the buyer or seller hasn’t squared off their position, these are the possibilities:
- Price > Contract Amount: If the price of the underlying security is more than the amount that is specified in the contract, the buyer will gain profit. Consequently, the seller would incur a loss.
- Price < Contract Amount: If the price of the underlying security is less than the amount specified in the contract, the seller will gain profit on the contract’s expiry date.
If both the parties i.e., the buyer and seller wish to hold on to the contract after its expiry date, they can opt to carry forward the contract to its next expiry date. Now the question is – What is the process of f&o settlement?
There are two ways in which these f&o contracts are settled between the buyer and the seller. They are as follows:
- Physical Delivery: The seller delivers a specific quantity of the underlying security to the buyer and the buyer in return, pays the full price to the seller.
- Cash Settlement: The difference between the current price (or spot price) and the contract price is paid in cash in exchange for the underlying security.
Here’s a snapshot of how some futures and options contracts are settled:
1. In-The-Money (ITM) Option: Physically settled
2. Out-of-The-Money (OTM) Option: Expire worthless
3. Futures: Cash-settled
P.S. Currency futures and options are cash-settled in India.
Expiry in the share market is a phenomenon that can lead to potential profits or losses of an above-average magnitude. The key is to trade the expiry with the best trading tools, features, and platform like Dhan.
Speaking of features, Trailing Stop Loss could come in handy during volatile expiry days. Take a look at the video below to know more.