Understand Expiry Day Option Buying Strategy

Options empower you to leverage your positions and manage risk effectively in the financial market. One compelling strategy, within intraday option trading, at your disposal is the act of buying options, with expiry day lending a particularly intriguing dimension to this approach. This strategy is known as the option expiry day strategy.

Option Expiry Day Strategy Meaning

An expiry day option buying strategy entails acquiring options contracts to profit from fluctuations in the underlying asset’s price on the options expiration day. These strategies specifically target options with expiration on a designated day, commonly known as expiry day. Short-term traders and speculators predominantly employ this approach to exploit brief price movements.

Within options contracts, two fundamental types prevail: call options and put options. Call options empower the holder to purchase the asset on or before the expiry date. Conversely, with put options you have the right to sell the underlying asset before or on the expiry date.

Working of Expiry Day Option Buying Strategy

Here’s how this strategy works:

Suppose the stock of Company ABC will experience a significant price increase on its expiry day, just a few days away. So, you:

• Begin by selecting the appropriate call option. Consider factors such as the strike price, the option’s premium, and the time remaining until expiry. Opt for a strike price that you anticipate the stock can reach or surpass on expiry day.

• Having chosen the call option, proceed to purchase it. This grants you the right to buy Company ABC’s stock at the strike price on or before the expiry day.

• As the expiry day approaches, vigilantly monitor the stock’s price. Your option becomes profitable if the stock price rises and surpasses your call option’s strike price.

• On expiry day, if the stock price is favorable, you can exercise your call option, acquiring Company ABC’s stock at the strike price. Alternatively, you can sell the option contract if it has gained value.

If the stock price doesn’t move as anticipated, a potential loss is limited to the premium paid for the option. You retain the choice not to exercise the option if it remains out of the money.

Why Traders Prefer Option Buying on Expiry Day

Here are the reasons why traders prefer buying an option contract on the expiry, making it a popular intraday option trading strategy:

• Low Premium Cost

On expiry day, option premiums, especially out-of-the-money (OTM) contracts, trade at very low prices because of time decay. You can enter trades with a smaller investment compared to earlier sessions in the series.

• High Intraday Volatility

Expiry sessions usually witness sharp price movements as positions are squared off or rolled over. This volatility can cause significant swings in the premium within minutes. As an option buyer, volatility is favourable because even a small directional move in the underlying can push your premium much higher.

• Defined Risk

When you buy options on expiry day, your risk is strictly limited to the premium you pay, which is often minimal. However, the potential gain is theoretically unlimited.

• Scalping Opportunities Expiry day premiums fluctuate rapidly over short periods, making them ideal for scalping. As a trader, you can buy options, capture a quick price move, and exit with small but consistent gains. Since premiums are low, the percentage returns on scalped trades can be very high even if the absolute profit per trade is small.

• Reduced Holding Period Risk

When you buy options earlier in the week or month, you must deal with overnight risks such as global market news, political events, or unexpected data releases. However, on expiry day, your trade horizon is limited to a few hours.

Key Risks in Expiry Day Option Buying Strategy

Buying expiry day options carries the following risks:

• Rapid Time Decay

On expiry day, option premiums lose value much faster than in earlier trading sessions due to theta decay. If you buy an option and the underlying stock or index does not move in your favour quickly, the premium erodes rapidly.

• Liquidity Traps

Many traders buy deep out-of-the-money (OTM) options on expiry day because they appear cheaper. However, liquidity in these contracts is often thin, meaning fewer buyers and sellers are active. Even if the underlying moves closer to your strike price, you may struggle to exit your position at a fair value due to wide bid-ask spreads.

• False Breakouts

Expiry days often see participation from large traders and institutions, which can lead to sudden price swings and unexpected breakouts that influence how retail option buyers react. You might see a sudden surge in the index that tempts you to buy a call, only to witness a sharp reversal as soon as you enter.

• Over-Leverage

Expiry day options are often priced very low, which tempts traders to buy multiple lots without considering the risks. For example, you may feel comfortable buying ten lots of an option priced at ₹5 each, thinking the risk is limited. However, if the option expires out of the money, the premium paid is lost in full.

• Slippage Risk

On volatile expiry days, orders may not always get executed at the price you see on your screen. When you place a buy or sell order, rapid premium fluctuations can sometimes result in your trade being executed at a less favourable price — a situation known as slippage.

Tips to Trade Options on Expiry Day Effectively

Here are some tips to trade options on expiry:

• Avoid taking oversized positions that can quickly impact your account balance. For example, if you usually trade 10 lots of Bank Nifty during the week, reduce it to 3 or 4 lots on expiry.

• Closely observe where open interest (OI) is building up or unwinding, especially in at-the-money and near-the-money strikes. A sudden rise in call OI can indicate strong resistance at a strike, while unwinding in puts may signal weakening support.

• Assess whether implied volatility is high or low before placing these trades. When volatility is already high, option premiums can fall rapidly, which may reduce potential gains for buyers. In such cases, option selling may be more effective, provided you maintain strict stop losses.

• Observe order book depth, bid-ask sizes, and sudden spikes in volume. A sharp increase in buy orders at a particular strike may suggest aggressive call or put writing.

• Decide beforehand when to participate actively and when to stay away. Many seasoned traders avoid the first 15 minutes due to erratic moves and also exit before the final 15 minutes to reduce the risk of wild swings.

To Sum Up

Expiry day option buying strategies present exciting opportunities, but it’s crucial to consider them within the context of a comprehensive trading or investment plan. Building a well-rounded and sustainable portfolio requires adhering to key principles such as diversification and effective risk management. Before venturing into options trading, especially if you are new to derivatives and financial markets, always seek advice from a professional advisor. Such guidance can also help refine your intraday option trading strategy, ensuring that your approach is both structured and disciplined.