Option Expiry – Importance of Duration and Rollovers

Understanding Option Expiry

Unlike equity shares or mutual funds, options contracts come with a defined lifespan. These contracts cease to exist after a pre-specified expiry date, set by the exchange. All open positions must be settled by the end of the trading session on expiry day, or as per exchange-defined timelines.

If an option is squared off before expiry, the expiration date becomes irrelevant to that contract. On the day of expiry, any rights associated with unexercised options expire and the contracts become worthless if not acted upon.

Why Duration and Cost Matter

A common hurdle for many traders is determining the ideal expiry date for their position. Knowing how much a stock or index might move isn’t enough, timing that move correctly is crucial.

For instance, if you expect the Nifty to rise by 5% in 10 days, purchasing a call option that expires in 2 days may not offer enough time. A more logical approach would be to select a contract expiring the following month.

When selecting an options contract on m.Stock, keep in mind two critical factors:

• Time until expiry
• Option premium (cost)

Longer-duration options offer more flexibility, but they come at a higher premium due to greater time value.

Example: Premiums Across Expiries (as on 19/08/22)

This table illustrates that as the duration of the contract increases, so does the option premium, primarily because of added time value.

In in-the-money (ITM) contracts, buyers may either sell the contract for profit or exercise it to acquire the asset. In out-of-the-money (OTM) contracts, however, the entire premium may become worthless on expiry, resulting in a loss limited to the premium paid.

Unlike options, futures contracts do not become void post-expiry. They carry binding obligations, making it essential to close or roll them over before the last trading day.

Expiry Styles: European vs American

• European options (as used in India): Can be exercised only on expiry day
• American options: Can be exercised any time before expiry

This distinction influences how and when a trader can act on their rights.

Trading Cycle: What to Know

On the NSE, options on indices like Nifty 50 and Bank Nifty, as well as individual stocks, follow a three-month trading cycle:

1. Near-month
2. Next month
3. Far-month

Each contract expires on the last Thursday of the expiry month. If Thursday is a holiday, the contract expires on the previous trading day. Additionally, Nifty 50 and Bank Nifty offer weekly contracts expiring every Thursday.

What is a Rollover in Options?

Rollovers are used by traders who wish to extend their positions beyond the current series. It involves:

• Closing the current expiry position, and
• Opening a new position in the next expiry series

Example:

If you're holding an August call option on Nifty and believe the index will rise further, you may exit August and enter September, thus maintaining your position.

Rollovers are most common on expiry day and help in:

• Sustaining exposure in the market
• Providing clues about trend strength, based on rollover patterns

What is the Rollover Ratio?

The rollover ratio gives insights into trend continuity. It is calculated as:

Rollover Ratio (%) =
(Open Interest of Mid + Far Month Contracts) ÷ (Total OI of Near + Mid + Far Month Contracts) × 100

When this ratio is higher than the previous series, it may signal trend continuation in the upcoming expiry—at least in the short run. To make better predictions, combine rollover ratios with other technical indicators.

Cost vs Duration: A Balancing Act

Longer-duration contracts may feel safer due to the time buffer, but they also come with:

• Higher premiums
• Increased break-even levels

Always weigh:

• Your market outlook
• Budget for premium
• Target time frame

Also, consider implied volatility and option Greeks (explained separately) for a more strategic decision.

Points to Remember

• Option contracts come with a fixed expiry date, unlike stocks.
• The longer the duration, the higher the premium due to time value.
• Always factor in both cost and time to expiry before entering an option.
• Rollovers allow traders to shift positions to the next expiry series without losing exposure.
• Use rollover ratios to analyze trend strength, but confirm signals with other tools.