Trading in the stock market can be both thrilling and potentially lucrative. Among the many techniques that traders employ, expiry-day trading has recently gained considerable prominence. This method revolves around the final day of options contracts, presenting distinct possibilities and hurdles for those who fully grasp its nuances.
What is expiry day trading?
Expiry day trading involves buying or selling options contracts on their last day of trading, aiming to profit from the heightened volatility and price swings that often accompany the countdown to expiration. In the Indian stock market, monthly options typically expire on the last Thursday of each month, while weekly options expire every Thursday. This strategy requires careful analysis and timing to maximize potential gains while managing risks associated with rapid price fluctuations.
At such times, traders buy these cheaper options to capitalise on quick price swings. Alternatively, they can also sell options with the expectation that they will expire worthless. In this situation, they are able to keep the premium.
Be aware that the key to success in expiry-day trading is accurately predicting these short-term market movements to secure fast profits before the options lose all value.
Importance of expiry dates in trading
Expiry dates in options trading mark the end of a contract's life. These dates significantly influence settlement, time decay, risk management, and overall market impact. For more clarity, let’s understand their importance in detail:
1. Contract settlement
On the expiry date, all options contracts must be settled. When it comes to buyers, they can choose to exercise their option, which means buying or selling the underlying asset or letting it expire worthless if it's not profitable. On the other hand, sellers are obligated to fulfil the contract terms if the buyer exercises the option.
2. Time decay acceleration
As an option nears its expiry date, its time value decreases rapidly. This process, called “time decay” or “theta”, accelerates significantly in the final days. Hence, traders need to be aware of this, as it can dramatically reduce the option's value. When unmanaged, it sometimes leads to substantial losses.
3. Increased volatility
It has been commonly observed that during expiry days, there is a surge in market activity as traders rush to adjust their positions. This flurry of trading often leads to increased volatility and higher trading volumes. Also, while this volatility can create profit opportunities, it introduces higher risks. Hence, traders must remain vigilant and strategic in their actions.
4. Risk management
To effectively manage risks in options trading, traders must know when contracts expire. That’s because traders might face unexpected outcomes or losses if they don't close or roll over their positions before expiry. Hence, properly managing expiry dates ensures that traders can control their exposure and avoid unwanted situations.
5. Market impact
Numerous studies have shown that the settlement of a large number of options contracts on expiry day impacts the broader market. This happens because when many options contracts reach their expiry date, traders have to either buy or sell the underlying asset to settle their positions.
This large-scale buying or selling activity affects the price of the underlying asset. Because of this high volume of transactions, it often leads to significant changes in the asset’s price and causes notable movements in the broader market. Therefore, traders must be aware of this expected impact to better anticipate market trends.
How does an expiry day option buying strategy work?
It is pertinent to note that executing an expiry day trading strategy requires a disciplined approach and a strict market watch. Let us see how you can execute it by following simple steps:
Step I: Identify a high-probability option
To begin with, you need to find an option with a high chance of increasing in value before expiration. You can base your search on “market trends” by:
- Analysing historical price movements and patterns of the underlying asset
- Looking for recurring behaviours that can indicate future price movements
Furthermore, you can also use technical analysis tools (such as Moving Averages, Bollinger Bands, Relative Strength Index) to identify optimal entry points.
Step II: Purchasing the option
Once you have identified the options contract, enter the trade by buying it at a time when you believe the price is favourable.
Step III: Keep monitoring price movements
Keep a close watch on the option's price and market conditions. You can use your trading account to continuously monitor the option's price. Specifically, look for significant price movements that could impact your trade.
Step IV: Stay informed about external factors
Follow financial news channels, online platforms, and market analysts for updates that could impact the underlying asset. Also, keep an eye on economic data releases, such as:
- Employment reports
GDP numbers - Interest rate announcements
Step V: Making the sell decision
Perform thorough analysis and decide when to sell the option. Analyse current market trends and compare them with your initial predictions. You can also use technical analysis to determine if the option's price has reached a level where selling would be profitable.
Furthermore, always assess your risk tolerance limit. Decide what is better for you:
- Holding longer
or - Selling immediately
By following these steps, you can make the most of this strategy. Are you interested in intraday trading? Learn about intraday trading time today.
How to make trades on option expiry day?
Keep these essential points in mind to make the most of expiry-day volatility:
- Assess market volatility: Observe changes in implied volatility and overall market sentiment.
- Set clear targets: Define entry, exit, and stop-loss levels to minimise unexpected losses.
- Manage position size: Control trade size to avoid excessive exposure, especially when volatility spikes.
- Monitor time decay: Options lose value quickly on expiry day, so stay alert to premium erosion.
- Stay updated: Follow real-time news and market events that might affect final price movements.
Benefits of expiry day option buying strategy
The expiry day trading strategy offers several benefits, particularly for traders who:
- Can effectively manage the risks
and - Stay informed of the latest market developments
Let’s study some major benefits of this strategy:
1. Potential for high returns
- As discussed above, when options near expiration, the underlying asset experiences significant price movements.
- This volatility creates an opportunity to earn substantial gains.
- Traders can take advantage of the price swings to enter and exit positions profitably.
2. High leverage
- Options allow leverage
- This means traders can control a large position with a relatively small investment.
- Through leverage, traders can amplify their profits if the underlying asset moves in the predicted direction.
3. Cost efficiency
- Usually, options nearing expiration are cheaper
- That’s because they have less time value
- This allows traders to enter positions with lower capital outlay.
4. Flexibility
- In this strategy, traders can quickly adapt to market conditions by making decisions based on real-time data.
- This is ideal for those who prefer “active trading”.
5. Limited risk
- The maximum loss is limited to the premium paid for the options.
- Also, traders can use “expiry day options” to manage their risks by:
- Hedging other positions
or - Diversifying their portfolio
- Hedging other positions
Expiry day options strategy - Mistakes to avoid
The expiry day trading strategy is highly lucrative and can offer significant returns. However, it comes with several risks. To maximise the chances of success, traders should be aware of some common mistakes and try to avoid them. Let’s explore them:
1. You waited too long before buying options
As expiration approaches, the time value of an option decreases rapidly due to time decay. If you wait until the last minute, you might miss out on potential profits. Thus, make your purchases earlier in the day. This will give you more time to benefit from potential price movements.
2. You failed to perform enough research
Without thorough research, you might make uninformed decisions. Hence, before buying options, you should always study the:
- Market trends
- Historical data
- Any relevant news
3. You did not consider volatility
Market volatility greatly impacts options prices. Usually, it is high on expiry days. When you ignore this factor, you purchase options at a higher price or miss out on profitable opportunities.
Therefore, always factor in the current volatility levels when making your decisions. Use tools like the VIX (Volatility Index) to gauge market volatility.
4. You tried to overextend yourself
In the hope of a big payoff, you purchased too many options, which increased the chances of incurring significant losses. To manage risk, limit the amount of capital you allocate to expiry day trades. Follow a disciplined approach and stick to your predefined risk trading plan.
5. You ignored diversification
Always remember that risk increases when you put all your investment into one option or underlying asset. Hence, control your risk exposure by spreading your investments across different options and underlying assets
6. You never made a trading plan
In one of the major blunders, you executed an expiry day trading strategy without a trading plan. Ultimately, you incurred losses by making emotional and impulsive decisions. Hence, always develop a clear trading plan that includes:
- Entry and exit points
- Risk management strategies, and
- Profit targets
7. You are not monitoring the market
It must be noted that unforeseen events dramatically impact options prices on expiry day.
Hence, stay informed about current events and market conditions. Prepare contingency plans to manage any unexpected changes.
8. You tried to time the market
Timing the market is tough even for experienced traders. Most traders who rely solely on predictions often face severe losses. Thus, focus on the fundamentals of options trading. Always make informed decisions based on solid research and analysis rather than trying to predict market movements.
9. You did not seek professional advice
As with all derivatives instruments, options trading is complex. Without professional guidance, you might miss important insights or strategies. Hence, always consult a financial advisor or broker with experience in options trading. They can provide valuable advice and help you avoid negative outcomes.
Bank Nifty option buying strategy
The Bank Nifty options buying strategy involves trading options connected to the Bank Nifty index. For the unaware, this index tracks the 12 most liquid large-cap banking companies in India. In this strategy, traders purchase options on the expiry day. This way, they can capitalise on the unique price movements that occur as options near their expiration.
To identify opportunities in the Bank Nifty index and understand market behaviour, most traders study historical price patterns to:
- Spot trading opportunities
and - Identify support and resistance levels
Also, they consider macroeconomic factors such as:
- Interest rates
- Government policies, and
- Global economic trends
This consideration helps in predicting market movements and adjusting their strategies. Furthermore, traders implement effective risk management techniques like stop-loss orders, position sizing, and portfolio diversification, to protect their capital.
These analyses allow traders to effectively execute strategy and also capitalise on market volatility for profitable opportunities.
Expiry day’s effect on market volatility
On expiry day, the stock market becomes more volatile, which can be both an opportunity and a risk for traders. Usually, this happens due to various factors. Let’s check them out:
1. Position squaring
As expiry day approaches, traders close out their positions. They do so to avoid holding them after the contract expires. This rush to buy or sell increases market activity and leads to greater price swings.
2. Delta hedging
Option sellers often need to buy or sell the actual stocks to balance their risks. This action is called delta hedging. It can push prices up or down quickly, which again adds to market volatility.
3. Arbitrage activities
Some traders look for small price differences between the spot market (current prices) and the futures market (future prices). To profit, they buy in one market and sell in the other. This strategy causes sudden price changes.
4. Roll-overs
When a contract is about to expire, investors might not want to settle or close their positions. Instead, they prefer to keep their investment going by moving their position to a new contract with a later expiration date. This process is called "roll-over."
It creates extra buying or selling pressure and causes market prices to fluctuate. Sometimes, this process of rolling over even creates temporary imbalances in buying and selling that lead to price fluctuations.
Conclusion
The expiry day trading strategy can be highly profitable if executed with discipline and careful analysis. By purchasing options on their expiry day and holding them until the end of the trading session, traders can capitalise on short-term price movements.
However, to succeed, it’s crucial to conduct thorough research and keep monitoring market conditions. Also, effective risk management (stop-loss orders and diversification) is important, as it protects capital.
Several traders spot trends to make money in the financial markets. Learn trend trading today and know when to buy or sell securities.
