Expiration risk refers to the potential of creating a large, unhedged position in an underlying due to the exercise/assignment process at expiration. The following characteristics of exercise/assignment of equity options at expiration create the potential for expiration risk:
- All long options that are in-the-money by $0.01 or more are automatically exercised unless the long option holder submits a “Do Not Exercise” request.
- All other long options are not exercised unless the long option holder submits an “Exercise by Exception” request*. This primarily affects customers that hold a long options position that expired OTM, but due to after-hours price action, it becomes ITM.
- Professional traders & market makers have until 4:30 PM CT on expiration to submit “Do Not Exercise” and “Exercise by Exception” requests to the OCC. (tastyworks customers need to submit these instructions to tastyworks by 3:15 PM CT)
- Exercises & assignments are processed overnight, so if you are assigned on a short option, there is no way to know until after expiration.
*An option is considered ITM/OTM based on the closing price. Additionally, "Exercise by Exception" requests requires the account to have enough buying power in order to process an exercise request.
To learn more about tastyworks' expiration risk process, then please click here.
If you have open short option(s) positions in your account after the market closes on expiration day, there is no way to know for sure whether or not you will be assigned. This means that spreads (verticals, iron condors, etc.) tend to create the most expiration risk because the long options have already expired by the time you know whether or not the short options were assigned. In other words, the defined risk position no longer become a defined risk.
The only way to completely eliminate expiration risk is to close short options before expiration and submit appropriate “Do Not Exercise” and/or “Exercise by Exception” requests for long options.
Example 1: Long Options
- Account deposits $5,000.
- Account buys 500 contracts of out-of-the-money SPY calls that are expiring that day for $0.10. (Total cost = $5,000)
- The account doesn’t sell the SPY calls before the market closes, they close in-the-money, and the account doesn’t submit a “Do No Exercise” request.
- SPY is down $3.00 the following day.
In the situation described above, all of the calls would automatically be exercised and the account would be long 50,000 shares of SPY the following day. If SPY was down $3.00, the account would lose $150,000.
Example 2: Spreads
- Account deposits $10,000.
- Account sells 200 at-the-money dollar wide put spreads in SPY that are expiring that day for $0.50. (Buying power reduction = $10,000)
- The spreads are out-of-the-money at the end of the day, so the account doesn’t close the position.
- SPY is down $3.00 in the extended hours and down $4.00 the following day.
In the situation described above, it is likely that the short puts will be assigned, but there is no way to know for certain until the following day. If the puts were assigned, the account would be long up to 20,000 shares. If SPY was down $4.00, the account would lose $80,000.