Options Expiration: Three Things You Need to Know

McCarty explains that in the S&P, open interest has tended toward the round strikes of 950 and 1000, with a significant overweight to the put side (over 100,000 contracts at the October 950 put strike, compared to 24,000 on the call, while at the 1000 strike the proportion stands at 105,000 puts vs. 32,000 calls).

"For [the] past several weeks, we've noted option trader positioning in October puts in anticipation of meeting liquidations or of liquidating their own funds. It'll be interesting to see how many contracts are actually put this month, as opposed to rolled into subsequent months. In this case, if puts are exercised and liquidated, then you could see some downward pressure into the expiration. The at-the-money straddle in the S&P is pricing in a 68-point move, and with Monday's move amounting to 86 points by closing bell, a move of this magnitude is entirely realistic."

3. Beware Expiration Week's "Volatility Crunch"

Traders of options on single stocks should beware of the "volatility crunch" -- the pinch that occurs when traders are caught long front-month options, which are cheap owing to measly time value, but which nonetheless require a large move in percentage terms in order to prove profitable.

"Right now, especially for those who want to trade in the October contract right before expiration -- there's this concept that people don't want to pay a lot for an option. Rather than looking at the potential percentage move that they need the stock to make in order for the bet to turn profitable for them, they look at price alone. This is especially true on the call side, when the market makes a substantial move, but not sufficient to reach the option's strike price and implied volatility comes off on the call side tremendously. The stock goes up, but the price of the call goes down because implied volatility has come off and there's no time value left to clinch the move," says Brian Overby, senior options analyst at TradeKing in Charlotte, North Carolina.

"Especially with the VIX at these elevated levels, traders should ask themselves how much they need to see a stock move in percentage terms to reach the strike and make the bet profitable," he adds. If the move is more than expected, he favors opting for call spreads (selling a higher strike call in tandem with the long lower strike call) or fewer contracts at a strike closer to the price of the underlying stock.

This was originally published on RealMoney on Oct. 14, 2008. For more information about subscribing to RealMoney, please click here.

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