Deciding to trade a stock option requires choosing an expiration month. Because option strategies require making modifications during the life of a trade, you need to know in what months the options will expire. The expiration month you choose will have a significant impact on the potential success of any option trade, so it is important to understand how the exchanges decide what expiration months are available for each stock.
At any given time, there are at least four different expiration months available for every stock on which options trade. The reason for this is that when equity options first started trading in 1973, the Chicago Board Options Exchange (CBOE) decided there would be only four months wherein options could be traded at any given time. Later, when long-term equity anticipation securities (LEAPS) were introduced, it was possible for options be traded for more than four months. (For background reading on options, see the Options Basics Tutorial.)
Not All Stocks Trade the Same Options
You may have noticed that not all stocks have the same expiration months available. Let's look at the expiration months available from September 2008 for three different stocks:
Microsoft: Sept 2008, Oct 2008, Jan 2009, April 2009, Jan 2010 and Jan 2011.
Progressive: Sept 2008, Oct 2008, Nov 2008 and Feb 2009.
CitiGroup: Sept 2008, Oct 2008, Dec 2008, Jan 2009, Mar 2009, Jan 2010 and Jan 2011.
The first thing you may notice is that all three have September and October options available. Next, both Microsoft and CitiGroup have options available in January 2009, January 2010 and January 2011, while Progressive does not. But then it gets more confusing. For the third month out, not one of the months matches those for any of the other two. And CitiGroup has an extra month trading: March 2009. Exactly how do the exchanges decide what expiration months should be available for each stock?
To answer that question, you need to understand the history of how the exchanges have managed the option expiration cycles. When stock options first began trading, each stock was assigned to one of three cycles: January, February or March. There is no meaning as to which cycle a stock was assigned - it was purely random.
Stocks assigned to the January cycle had options available only in the first month of each quarter: January, April, July and October. Stocks assigned to the February cycle had only the middle months of each quarter available: February, May, August and November. Stocks on the March cycle had the end months of each quarter available: March, June, September and December.
The Modified Expiration Cycles
As options gained in popularity, it soon became apparent that both the floor traders and individual investors preferred to trade or hedge for shorter terms. So the original rules were modified, and in 1990, the CBOE decided that every stock would always have the current month plus the following month available to trade. This is why all three of the stocks in the above example have September and October options available.
Every stock has at least four expiration months trading. Under the new rules, the first two months are always the two near months, but for the two farther-out months, the rules use the original cycles.
It may help to look at an example. Let's say it is the beginning of January, and we are looking at a stock assigned to the January cycle. Under the newer rules, there is always the current month plus the following month available, so January and February will be available. Because four months must trade, the next two months from the original cycle would be April and July. So, the stock will have options available in January, February, April and July.
What happens when January expires? February is already trading, so that simply becomes the near-month contract. Because the first two months must trade options, March will begin to trade on the first trading day after the January expiration date. So the four months now available are February, March, April and July.
Now comes the tricky part: once the February options expire, March becomes the current contract. The following month, April, is already trading. But with March, April and July contracts trading, that's only three expiration months, and we need four. So, we go back to the original cycle and add October because it is the next month in the January cycle after July. So the March, April, July and October options will now be available. The same reasoning determines what months are trading for stocks on the February and March cycles.
If a stock has LEAPS available, then more than four expiration months will be available. Only the most popular stocks have LEAPS available. That is why in our example above, Microsoft and CitiGroup had them while Progressive did not. (For background reading on LEAPS, see Using Options Instead Of Equity, Using LEAPS With Collars and Using LEAPS In A Covered Call Write.)
Once you understand the basic option cycle, adding LEAPS is not difficult. LEAPS are long-term options that, with some exceptions, are no more than three years out and usually trade with a January expiration date. If a stock does have LEAPS, then new LEAPS are issued in May, June or July depending on the cycle to which the stock is assigned.
When it is time to add (or go beyond) January in the normal rotation (not including the current or near-term contract), the January LEAPS that has been "hit" becomes a normal option, which also means the root symbol changes and a new LEAPS year is added. Let's go back and look at our original examples and walk through what happened to Microsoft and CitiGroup.
For Microsoft we go back to May of 2008. The months available for Microsoft then were May 2008, June 2008, July 2008, October 2008, January 2009 and January 2010. Once the May options expired, another month needed to be added. The two front months, June and July, were already trading, as was the next month in the cycle: October. So, following the rules for the January cycle, we would need to add the January expiration month.
For a stock that did not have LEAPS, no further action would be necessary, and it would trade the four months of June, July, October and January 2009. But Microsoft already had LEAPS trading that expire in January 2009. So, instead those were converted to standard options (with an accompanying symbol change), and January 2011 LEAPS were added.
Nothing out of the ordinary happened to CitiGroup when the May options expired, since it is on the March cycle. June was already trading, so only the month of July had to be added. After the May expiration, CitiGroup now traded the months of June, July, September and December, plus LEAPS in January 2009 and 2010.
But let's follow through what happens after the June expiration. For the regular options, July, September and December were already trading, so all they needed to do was add the second front month: August. But for March cycle stocks like CitiGroup the January 2009 LEAPS converted to standard options after the June expiration date, and the January 2011 LEAPS were introduced at the same time.
So, on the Monday after the June expiration, CitiGroup had options trading in July, August, September, December and January 2009, as well as LEAPS in January 2010 and January 2011. Cycle-three stocks follow the same procedure, whereby the 2009 LEAPS convert to regular options after the July expiration date, and the 2011 LEAPS are added.
How Can You Tell What Cycle a Stock Is On?
You cannot tell what cycle a stock is on by looking at the front two months: all stocks will have those months available. To figure out the cycle, you need to look further out at the third and fourth months. You can usually tell from the third expiration month available. Just keep adding three months to the third month until you reach January, February or March. CitiGroup has December as the third contract month, so if we add three months we arrive at March. We therefore know that CitiGroup is on the March cycle.
That said, you have to be careful if the third month out happens to be January. While that may indeed mean the stock is on the January cycle, any stock with LEAPS will also have January options trading. In that case, you need to look farther out to see what the fourth month is to confirm what cycle the stock is on. In the above example, Microsoft has April available, so we know for sure that it is on the January cycle.
Option-expiration cycles for stocks may seem a bit confusing, but if you take a little time to understand them, they become second nature. Because you may need to make adjustments during the life of a trade, it can be very important to know what expiration months will become available in the future. Understanding the expiration cycles is just one more way to help you increase your success rate when trading options.