by Raven Lebeau

Created on: February 28, 2008

All stock options have an expiration date. With a few exceptions, options expire on the third Friday of every month, known as expiration Friday. For those of us who deal in "retail options", making most of our money on the sell side, the motto is "I live for expiration Friday!" When the options a trader sells expire worthless, he no longer has to worry about them being exercised against him.

Yes, selling options can be a little nerve wracking at times. Here you are, having sold someone the right to (for example) make you purchase one hundred shares of Google at 700 dollars per share. As the price of Google plummets, you wait for the proverbial ax to fall, anxiously watching your inbox for the dreaded assignment notice.

Google stock options are US style options, meaning that they can be exercised at any time from purchase till expiry. If you buy an option, US exercise style gives you the added bonus of being able to exercise the option early if it is in your favor to do so. In reality, the advantage is a small one. It is rare that you will make money by exercising a stock early. While sudden changes in the stock price may make exercise more profitable than selling the option, it doesn't happen often. People who buy options as a speculation on price changes usually end up selling the option at a higher price rather than exercising it early.

Most stock options on individual companies are US style, however many indices and ETFs (exchange traded funds) are European style, meaning that they can only be exercised at expiry. The value of an index or exchange traded fund is the weighted average of the prices of the underlyings which comprise it. At expiry, this "settlement value" is calculated and winners and losers are determined. Most European style options are cash settled, meaning that there is no "stock" that changes hands. If I purchased a call on, say, HVY (a gold index) at a strike price of 70, and HVY settles at 80, then the cash I would receive is computed by the following method:

If the call is out of the money, the cash settlement is zero. (In this example, I would get nothing if HVY had a value below 70 at expiry.) If the call is in the money, subtract the strike price form the settlement value of the index, and multiply by the appropriate multiplier. In this case, the multiplier is 100, and so I would make 1000 cash settlement from the trade, minus my broker's commission.

The multiplier on most index options is 100 because stock options on individual stocks

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