Options Definition: Expiration Date
On an options exchange, every 3rd Friday of the month
is an expiration day – this means that a number of options series expire
on this day.
At the end of the expiration date, all those
options whose strike prices are higher than the price of the underlying
stock or index will be worthless. On the other hand, those options
series, whose strike prices are lower, will have some intrinsic value and
may be exercised. In the case of put options, the opposite applies.
The options expiration date is the most important
factor in calculating options prices:
- The Black Scholes model is used to price European
style options. This 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.
- The binomial model is used to price American style
options. The binomial model calculates a tree of stock prices for
various given time intervals within the expiration period. Using the
volatility of a stock and the time left to expiration, the model
determines how much a stock might increase or decrease in value. This
calculation gives all possible prices for a stock. Then, working
backward from the expiration date to the present, option prices are
calculated using a risk neutral valuation. Ultimately, a each option is
Option Style: There are American style and
European style options. American style options can be exercised at any
time up to the expiration date. European style options may be exercised
only on the expiration date itself.
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