Why is Options Trading more risky on the expiry day?
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- Updated On:13-Jul-2021
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Short Answer
Options trading involves many factors such as Options Greeks. Options Greeks like Delta, Theta, and Gamma have the most impact on Option prices towards the end of the expiry. The option premiums are impacted highly by Gamma and Delta on the day of expiry. Learn more about Options greeks and how they impact option premiums.
Detailed Answer
What is Expiry in Options?
Options are mere contracts that are traded with the promise to exchange the underlying on a particular date. This particular date till when the option contracts are valid is known as the Expiry date. Sock options expire on the last Thursday of every month in India. Index Options such as Nifty & BankNifty have weekly options that expire every Thursday. In the same way, Options traders have to either square off their positions or take/give delivery of the underlying on the date of expiry.
Why is options trading risky on the date of Expiry?
Options trading is considered risky on the date of expiry due to two main reasons, which are-
1.Options expiring In the Money
On the date of expiry, if you have any open ITM (In The Money) stock options. And by the end of the day, if you forget squaring them off. You will have to take/give delivery of the underlying shares as per your position. For example, if you had an ITM Call Option of Reliance Industries then you will have to buy 1 Lot of Reliance at the given price. That turns around to be somewhere close to Rs 5,20,000. In the present climate, 5.2 lakh might not be so easy to fund for a small retail trader. Due to this reason, it is advised to square off any Option Positions before the date of expiry to prevent any complication of Delivery.
2.Gamma Effect
Every Options contract is made up of two components. Intrinsic value and Time value. The time value diminishes completely by the last hour on the expiry day. Due to this, the Options are only traded on their intrinsic value. Now, Gamma increases on the expiry day. Gamma is an Option Greek that denotes the change in Delta. Due to the increase in Gamma, a 50 point move in the underlying can cause to Option price to swing as high as 45-50 points. Due to this phenomenon, OTM Option prices that are extremely cheap can sometimes end up getting ITM. In this situation Option traders especially Options sellers tend to lose a lot. A cheap option of 4-5 rupees can end up getting 60-70 rupees within minutes due to a massive swing in the underlying. This might be beneficial for an Options buyer as the increase in the premium can turn out to be profitable for an Options buyer. But this has its own dangers. If an Options buyer buys an OTM (Out of The Money) stock option and if it goes In the money.The problem to take delivery arises. liquidity can be low in ITM options resulting in the obligation to undertake delivery.
Conclusion
Due to the following reasons, options trading especially option selling is considered risky on the day of expiry. There are some ways in which you can minimize these risks. Firstly trade in Index Options (Nifty, BankNifty) as here you are not under the obligation to carry out the delivery. In this way even you have an ITM Option, you can leave it withing worrying about taking delivery. Secondly, you can square off all your Options trades 2-3 hours before the expiry time. By following this, you can evade the high volatility in the last couple of hours.
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