Options Expiration Cycles
Deciding which stock option to trade based on your expectations for the underlying stock requires choosing an expiration month. And the expiration month you choose can have a significant impact on the potential success of any option trade. Understanding how the exchanges decide what expiration months are available and when LEAPS should convert into regular options, can help you in your trading.
There are at least four different expiration months available for every optionable stock. The reason for that is because when equity options first started trading in 1973, the Chicago Board Options Exchange (CBOE) decided there would only be four months of options traded at any given time. Later, when LEAPS (Long Term Equity Anticipation Securities) were introduced, it was possible for more than four months to be traded.
Not all Stocks Trade the Same Options
You may have noticed that not all stocks have the same expiration months available. As I write this we are coming up to the June 2006 expiration date so I will look at the expiration months that are currently available for three different stocks: Microsoft (Symbol: MSFT), CitiGroup (Symbol: C), and Stericycle (Symbol: SRCL).
Microsoft – June, July, October, Jan ‘07, Jan ’08, and Jan ‘09
Stericycle – June, July, August, and November
CitiGroup – June, July, Sept, December, Jan ’07, and Jan ‘08
The first thing you may notice is that all three stocks have June and July options available. Next, both Microsoft and CitiGroup have options available in January 2007 and January 2008 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 Microsoft has an extra month trading, January 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. Stocks continue to be assigned to one of these three cycles, although there is nothing meaningful about which cycle a stock is assigned to. It is purely random.
A January cycle originally meant that options would be traded on the first month of each quarter. So 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 only had the middle months of each quarter available: February, May, August, and November. And stocks on the March cycle were 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 floor traders and individual investors preferred to trade or hedge for shorter terms. So the original rules were modified and the CBOE decided that every stock would always have the current month plus the following month available to trade. That is why all three of the stocks in the above example have both June and July options available.
As I mentioned in the beginning, every stock has at least four expiration months trading. The first two months, under the new rules, are always the two near months. But for the two farther-out months, the rules still use the original cycle months.
Since this may seem a little confusing, 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 new 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. Since the following month must also trade, on the first trading day after the January expiration date, options for March will begin to trade. So now we have February, March, April, and July available.
Once the February options expire, March becomes the current contract. The following month, April, is already trading. But with the March, April, and July contracts already 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 is used to decide what months will trade for stocks that are on the February and March cycles.
LEAPS are long-term options that are no more than three years out, with some exceptions, and usually trade with a January expiration date. If a stock has LEAPS available, then more than four expiration months will be available. But not all stocks have LEAPS available, only the most popular ones. That is why in our example above, Microsoft and CitiGroup had them but Stericycle did not.
Once you understand the basic option cycle, adding LEAPS is not difficult. If a stock does have LEAPS, then new LEAPS are issued in May, June, or July depending on the cycle the stock is assigned to. When it is time to add (or go beyond) January in the normal rotation (not including as the current or near-term contract), the January LEAPS that has been “hit” becomes a normal option. This means that, even though the terms of the options contract do not change, the root symbol does and all your trading records will now show a completely different symbol for your positions in those LEAPS. At the same time, a new LEAPS expiration year is added.
This may seem confusing, so 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 2006. The months available for Microsoft at that time were May, June, July, October, Jan ’04, and Jan ’0 5. 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. It would then trade the four months of May, June, Oct, and Jan ’07. But Microsoft already had LEAPS trading that expire in January 2007. So what happened is that those LEAPS were converted to standard options, and then January 2009 LEAPS were added. The conversion from LEAPS to regular options is accompanied by a symbol change for the affected LEAPS.
When the May options expired, nothing out of the ordinary happened to CitiGroup since it is on the February cycle. June was already trading, so all that needed to be done was to add the month of July. So after the May expiration date, CitiGroup began to trade the months of June, July, September, and December, plus the same LEAPS in January 2007 and 2008. But let’s follow through what happen after the upcoming June expiration date.
For the regular options July, September, and December will already be trading, so all that needs to be done is to add a second front month, August. But for all cycle 2 stocks that have LEAPS available (such as CitiGroup), after the June expiration date the January 2007 LEAPS will convert to standard options and the January 2009 LEAPS will begin trading at that time.
So on the Monday after the June expiration date CitiGroup will now have five standard option months trading: July, August, September, December, and January 2007. There will also be LEAPS in January 2008 and January 2009 available as well.
Stocks generally have four months of listed options available, but once LEAPS are converted it is possible to have five months of listed options. Even once the June expiration date passes, there will be still more to do. Cycle 3 (March) stocks will follow the same procedure after the July expiration date. At that time, any stocks on the March cycle with LEAPS available will see their January 2007 LEAPS convert to regular options while the January 2009 LEAPS will be 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 two months available. To figure out the cycle the stock is on you need to look further out at the third and fourth months.
You can often tell from the third expiration month. Just keep adding three months to the third month until you reach January, February, or March. CitiGroup has September as the next contract month available. Adding three months gives you December (which is already trading as well). Add another three months and you get March, so now we know that CitiGroup is on the March cycle.
But 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 the January options trading as well. So if January is the third month out (which would happen to Microsoft after the August expiration date) you need to look further out to the fourth month to confirm what cycle the stock is on.
Option expiration cycles for stocks may seem a bit confusing, but if you take a little time to understand them they become second nature. You need to understand the process of converting LEAPS to standard options to keep your trading records up to date. Some option strategies may require that you make adjustments during the life of a trade, so it also helps to know what contract months are going to be available during the life of the trade. Understanding the expiration cycles is just one more way to help you increase your success rate when trading options.