Expiry Trading Strategies: Conducting a Backtest for Performance Insights

It’s a well-known fact that as options expiry day approaches, the biggest-cap stocks with actively traded options tend to witness huge trading volumes (and sometimes increased volatility). In fact, the most important day in stock trading is the expiry day. But what is expiry in options trading?

In options trading, an expiry time (or expiration time) is the time at which an options contract becomes void and can no longer be used. In the US, the options expiration date is the third Saturday of the expiration month, but the last day of trading is the business day (usually the Friday) preceding that expiration time. Because of the way it affects stock prices, options expiry trading day is a strategy for stock day traders.

Because of the increased volatility (see more below) any expire trading strategies might be worthwhile to explore. In this post, we take a look at expiry in options trading, at the end of the article, we present you several expiry options trading strategies that is backtested. There is no anecdotal evidence on this website!

What is expiry in options trading?

Options are financial derivative contracts that give the holder the right, but not an obligation, to buy or sell the underlying asset (say stocks) to the option writer at a specified strike price on or before expiry. At expiry, the contract becomes automatically useless, and the holder cannot exercise it.

The expiry time (or expiration time) is the time at which an options contract becomes void and can no longer be used. It is the time on the expiration day when the options contract ceases to exist. In the US, the options expiration date is the third Saturday of the expiration month, and the expiration time is 11:59 a.m. EST.

The expiration date and time should not be confused with the last day of trading in an options contract, which is usually the third Friday of the expiration month or the Thursday before it if the Friday is a public holiday. The expiration time is when the option actually expires, while the last day of trading is the deadline for the holder of the option to make their intentions to exercise the option known. Here is how the Nasdaq Exchange explains it:

The time of day by which all exercise notices must be received on the expiration date. Technically, the expiration time is currently 11:59 a.m. [Eastern Time] on the expiration date, but public holders of option contracts must indicate their desire to exercise no later than 5:30 p.m. [Eastern Time] on the business day preceding the expiration date.

What is options expiration week?

An option expiration week is the week of an options contract is to expire. It is the week that an options contract would expire. In the US market, stock options expire on the third Saturday of every month, but trading and exercising the options contract ceases on the Friday before that third Saturday of the month — except when Friday is a public holiday, in which case the expiration date becomes the trading day (Thursday) before that Friday.

So, the third week of the month is an options expiration week. During the expiration week, large-cap stocks with actively traded options tend to have substantially higher average weekly returns. This is referred to as the Options Expiration Week Effect (OPEX) or Options Week Anomaly/Seasonality.

When the options on stocks, stock index futures, and stock index options all expire on the same day, the expiration week is called a quad witching options expiration week. We witness this only four times per year — March, June, September, and December.