Options expiry date

The premium of an option with zero intrinsic value is composed solely of time value. Time value reflects the potential for an option to move more deeply into the money before expiry. It diminishes up to the options expiry date, when it becomes zero. The price of an option on expiry is composed solely of intrinsic value. 

No thumbnail sketch of the UK linker market s early days would be complete without a mention of the one-off innovation of an index-linked convertible gilt, nicknamed the Maggie Mays. The 2% Index-Linked 1999 was convertible into a nominal bond (10.25% 1999) at three future conversion dates. At a time when inflation remained volatile, and with the term to option expiry spanning a general election whose outcome was uncertain, seldom has so much optionality been sold so cheaply. The bonds were all (or almost all) converted. 

Expiry Date (or Maturity Date)— All options have a finite life. The last date when the holder can exercise his right is the option s expiry date. In the example given earlier, this was three months from now. European Style— This is nothing to do with geography A European style option is one which can only be exercised on the expiry date, not before. 

American Style— In contrast, an American Style option can be exercised at any time up to and including the expiry date. 

As an example, in March 2003 bond options expiring in April, May, June, and September were all available. The first three were exercisable into the June futures contracts, while the last one was exercisable into the September futures contract. Although all four expiry dates were theoretically available, only those options exercisable into the front futures contract (the next one to mature) were liquid. On 7 March 2003, the front contract was the June 2003 future, and over 99% of all futures trades and 99.9% of bond options trades involved this contract. Exhibit 17.7 provides a breakdown of these figures, showing the total number of contracts traded on that day. 

The longer the option s time to expiry, the more valuable is the option. In all cases, the options expiring in May are more valuable than those expiring in April with the same strike price and, similarly, June options are more valuable still. This is sensible when one thinks of the risk experienced by the option seller. The further the expiry date, the greater the uncertainty as to where the price of the underlying bond will be in the future, and therefore the more valuable the right to execute a trade in the future at a price fixed at the outset. 

You can see why a cap is actually a combination of single-period options by thinking about what happens every six months. In our example, the expiry dates of the nine caplets are set to coincide with the company s EURIBOR setting dates. Six months after the loan commences, the rate for the second interest period will be set by reference to the EURIBOR fixing that day. On the same date, the first caplet expires. If EURIBOR is above the strike rate of 3%, the company will exercise the caplet and receive compensation if EURIBOR is lower, the company will simply let the caplet expire worthless. The same process will apply six months later, and so on. 

The time value of an option is the amount by which the option value exceeds the intrinsic value. Because of the risk they are taking on, illustrated in the payoff profiles above, option writers almost always demand premiums that are higher than the contracts intrinsic value. The value of an option that is out of the money is composed entirely of time value. Time value reflects the potential for an option to move into, or more deeply into, the money before expiry. It diminishes up to the option s expiry date, when it becomes zero. The price of an option on expiry is composed solely of intrinsic value. FIGURE 8.4 lists basic option market terminology. 

Expiry date The last date on which the option can be exercised, also known as the maturity date... 

This rule applies to European put options on their expiry date as well as to American puts. This means that a put option cannot have a value greater than the present value of the strike price at expiry. This is expressed formally in (8.3). 

Equation (8.21) can be simplified as (8.22), the well-known Black-Scholes option pricing model for a European call option. It states that the fair value of a call option is the expected present value of the option on its expiry date, assuming that prices follow a lognormal distribution. 

Consider two portfolios, Y and Z. Y consists of a call option with a maturity date T and a zero-coupon bond that pays out Xon T Z consists of a put option also maturing on date T and one unit of the underlying asset. The values of portfolios Y and Z on the expiry date are given by equations (8.24) and (8.25), respectively. 

An option is a contract between two parties the option buyer and the option seller. The buyer has the right, but not the obligation, to buy or sell an underlying asset at a specified price during a specified period or at a specified time (usually the expiry date of the contract). The price of an option... 

If the owner of an option elects to exercise it and enter into the underlying trade, the option writer is obliged to execute under the terms of the contract. The price at which an option specifies that the underlying asset may be bought or sold is the exercise, or strike, price. The expiry date of an option is the last day on which it may be exercised. Options that can be exercised anytime from the day they are struck up to and including the expiry date are called American options. Those that can be exercised only on the expiry date are known as European options. 

LME lead options can be traded monthly for up to 15 months forward. Under Exchange rules the declaration or expiry date (the latest date an option can be exercised before it is automatically abandoned), is the first Wednesday in each month, and the prompt (or delivery) date, the third Wednesday. For lead options, the strike price gradation is 20/ton. Traded options in lead have been relatively less popular than those in other metals (see Table 16.1), but their usage has grown. 

To provide an idea of which of the EURIBOR contracts are liquid. Exhibit 17.12 shows the trading volumes on 7 March 2003 for the 10 expiry months available on that date. As with the bond options discussed earlier, the March 2003 options are exercisable into the March 2003 futures contract, the April through June 2003 options are exercisable into the June 2003 future, and the remaining options are exercisable into the future expiring in the same month. 

Traded options were introduced by the LME in May 1987. They are now available against the underlying futures contracts for six LME metals (but not aluminium alloys), denominated in all major currencies, and registered with the ICCH. These options are traded (and have all the essential characteristics of a commodity) because they can be freely bought and sold until expiry. While both the strike price and prompt date are fixed, the premium can vary ... 

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