Option Cycle

Options are financial instruments that give the buyer the right, but not the obligation, to buy or sell an underlying asset at a predetermined price within a specified time period. An essential concept within the realm of options trading is the “Option Cycle,” which refers to the standardized set of expiration dates available for options on a given stock or index. Understanding the option cycle is crucial for traders and investors as it significantly affects the strategy selection, premium calculation, and risk management.

Types of Option Cycles

There are three primary option cycles, commonly referred to as Cycle 1, Cycle 2, and Cycle 3. Each security that has options available belongs to one of these cycles, which helps spread out expiration dates more uniformly across the trading calendar year.

1. Cycle 1 (January Cycle): Options in this cycle expire in the months of January, April, July, and October.
2. Cycle 2 (February Cycle): Options in this cycle expire in the months of February, May, August, and November.
3. Cycle 3 (March Cycle): Options in this cycle expire in the months of March, June, September, and December.

Each of these cycles ensures that there is an equitable distribution of options expirations every month, providing traders with continuous opportunities to roll positions and manage risk.

Front Month and Back Months

Options are typically available based on their time to expiration:

• Front Month (Near-Term): This is the closest expiration month. It is the current month if an expiration date has not yet passed. For example, if today is February 1, 2023, and the February expiration has not yet occurred, then the February 2023 option is the front-month option.

• Back Months (Long-Term): These are options that expire in farther months. These could be the next one, two, or several months out, depending on the chosen option cycle and the trader’s strategy.

LEAPS (Long-Term Equity Anticipation Securities)

Apart from standard cycle options, LEAPS (Long-Term Equity Anticipation Securities) are options contracts with extended expiration dates, typically ranging from one year to three years from the issue date. They allow investors to adopt a long-term view of the underlying asset and hedge positions over a longer timeframe.

Expiration and the Role of Weeklies

Options typically expire on the third Friday of the expiration month; if the third Friday is a holiday, expiration occurs on the Thursday immediately before. Recently, Weeklies have gained popularity. These are options that expire weekly, offering traders greater flexibility and opportunities for short-term trading strategies.

Option Expiration Process

The option expiration process is critical to understand:

1. Automatic Exercise: In-the-money options (options with intrinsic value) are usually exercised automatically by the broker. The holder of an in-the-money option will be assigned the underlying asset.
2. Expiration and Settlement: Out-of-the-money options (options with no intrinsic value) expire worthless.

Knowing the specific details of expiration, including cut-off times and settlement processes, helps traders make informed decisions.

Impact on Trading Strategies

Different types of option cycles influence various trading strategies, such as:

1. Covered Calls and Protective Puts: Engaging in these strategies would require understanding the available expiration cycles for the underlying stock.
2. Calendar Spreads: Involves buying and selling options with different expiration dates to exploit time decay and volatility.
3. Iron Condors and Butterflies: These multi-leg options strategies also demand a thorough insight into the option expiration cycles.

Technological Tools and Resources

In modern trading, sophisticated technology tools are available to assist traders in managing option cycles effectively:

1. Trading Platforms: Brokerages offer platforms with real-time data and analytics to track option cycles.
2. Financial Calculators: These tools help in understanding Greeks (Delta, Gamma, Theta, Vega) across different expiration months.
3. APIs and Algorithms: Advanced traders use APIs and algorithmic trading systems to automate their strategies considering cycle rules. Fintech firms such as Robinhood and Interactive Brokers provide extensive APIs for this purpose.

Conclusion

The option cycle is an integral aspect of options trading, ensuring a systematic approach to expiration dates. This cyclic pattern of expiration influences various trading strategies and risk management techniques. Leveraging modern trading platforms and technological tools can significantly enhance traders’ ability to navigate the intricacies of option cycles effectively.