Futures and options are the derivatives of stocks traded in the derivative market. A future is an asset you are obligated to buy at a specific date and a certain price, whereas, with an options contract, the trader has the right to buy or sell the asset but is not obligated to do so.
Well, that was just an introduction because you have already learned that in our guide, Future and Options: An Introduction. So get ready, because this one is about to get a bit technical. Since you are already aware of what trading in the Future and Options is, let’s take it further and learn about Future and Options expiry, call option and put option.
Let’s take it this way, in cinemas, there’s a time when the old movie is removed from the big screen and the recently released one, is put up. So the date when the old one is removed is its “expiry day’.” Just like that, there’s a day when the futures and options contract expires too, most of the time, it’s the last Thursday of the month. And on this date, the contract is declared invalid. Let’s get to know it briefly so you can understand it better.
What is an expiry date?
In simple terms, expiry dates are the dates in the stock market when a contract expires in the derivatives (futures and options) market. So it’s nothing complicated, the expiration dates are simply the dates when the contracts expire. Every futures and options contract is based on an agreement to buy or sell any underlying security. Now, this security can be anything: a commodity, a share, a currency, or anything else. So, quite obviously, the contracts on which the investors agree have an expiry date before which the underlying asset has to be either bought or sold.
Since each trading market has its own expiry, let’s find out what the expiry is in the derivative market.
What is the expiry in a derivative market?
You must be wondering for a while now why the word “derivative” is used again and again, so let’s get to know it first. It is basically a security that is either derived from or dependent on an underlying asset. So this is between the buyer and seller that are involved in the trade of that underlying asset. So the “derivative expiry” refers to the expiry date of that derivative contract.
When you enter into a futures and options contract, you will be asked for the expiration date of the contract. So when the derivative contract expires, it won’t be valid after that.
Since there’s no “particular” expiry day for a contract, it’s important that we learn about different expiry days related to different contracts.
Expiry Dates with Different Contracts
Regardless of what you are dealing with today, you will have access to three different types of contracts, and each of them has distinctive expiry dates in the derivatives market. Let’s have a look:
- The far month contract
- The near month contract and
- The next month contract
It just sounds a bit technical, but it’s actually quite easy to understand. The far-month contract is the one that occurs on the last Thursday of the third month from the date you entered into the futures and options contract. Just like that, the next month contract is the one that will expire on the relevant Thursday of the next month of your entry. And finally, the near month contract is the one that is aligned with the last Thursday of the present month of your entry into a futures and options contract.
Let’s understand it with an example:
If you trade NIFTY 50 futures in January 2023, the expiry dates will be:
- The far month- the last Thursday of March 2023
- The near month- the last Thursday of January 2023
- The next month- the last Thursday of February 2023
Expiry day, expiry day, expiry day. You have learned quite a lot about it, but what happens on that day? That might still be a mystery for you, which we are going to resolve now.
What Happens on Expiry Day?
On any online trading exchange, two kinds of derivatives contracts can be traded by investors: futures and options. Traders and investors enter into such contracts with the intention of buying or selling the underlying asset at a predetermined price on a specific future date. Now, this future date is basically the date of the contract’s expiration. So on this particular day or date, the trader or investor who has entered the futures contract is obligated to fulfil the agreement. And on the other hand, if the trader and investor have entered into an options contract, they have the choice to either fulfil the agreement or pass it on until it expires on its own.
After learning about the expiry day, you should study about derivatives contract settlement. Since we know the derivative contract is resolved on the expiry day, let’s look at the accommodation.
The derivative settlement, in simple terms, is a process through which the contracts reach the buyer or the seller. Here are the three ways in which the settlement takes place:
- Cash settlement
- Delivery of a physical nature and
- Squaring off
Cash settlement takes place in derivative contracts where the underlying assets are equity. Here, the difference between the derivative price and the spot price is calculated. And then, the resultant amount is calculated and delivered in exchange for the question. Keep in mind that no physical delivery takes place here with any security or asset.
The seller of the derivative contract delivers the underlying asset’s quantity to the buyer.
The use of squaring off in the derivative settlement is just another way in which the settlement can take place. However, there must be another derivative contract that you purchase in order to offset your current position. And with this, it will have the function of canceling out the current position you are in.
In today’s investment world, futures and options can be profitable if you know how to trade. You will have to start from the beginning by enrolling in some stock market courses, doing your homework, and opening a demat account, which will give you a grip on trading at first.