Deciding to trade a stock option requires choosing an expiration date. 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.
The Modified Expiration Cycles
As options gained in popularity, it soon became apparent that both 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 further-out months, the rules use the original cycles.
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 to be traded for more than four months.
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.
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.
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. It might seem dated, but it is a great grouping to use as an example, and the rules haven't changed.
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. From there, 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 was 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 Bottom Line
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.