The Expiration Process and LEAPS
We all know that an option contract typically has the following elements: type, which can either be a right to buy shares of stock (called calls) or the right to sell shares of stock (called puts); style, which can be American, European or Capped, depending on when you can exercise the option; underlying security which, more often than not, are shares of stocks; unit of trade consisting of the number of shares; the strike price or option price and expiration. But have you ever wondered how the expiration process happens? Is there even such a thing as an expiration process? How about LEAPS? What are they and how do they expire?
Exercise and Expiration Process
All stock options have an expiration date which is the very last day of an option’s existence. This date is usually the third Saturday of the expiration month for the listed stocks. This is usually also the deadliest deadline for brokerage firms to submit to the Options Clearing Corporation (OCC) their client’s exercise notices. Bear in mind, however, that each stock exchange and brokerage firms have varying procedures and rules in which the holder of the option must comply regarding the last day the holder can give instructions to the brokerage firm to exercise the stock option.
To make the process of exercising stock options before their expiration, the OCC have come up with a process called Exercise-by-Exception also known as ex-by-ex, applicable to all brokerage firms that are Clearing Members of the OCC. Under ex-by-ex, the OCC establishes an in-the-money threshold. The term in-the-money means that for call options the strike price is below the fair marker value of the stock whereas for put options it is in-the-money if the strike price is above the fair market value of the stock. According to ex-by-ex, any contract that is at or above the in-the-money threshold shall be exercised except if one of the Clearing Members specifically directs OCC not to exercise it. All other option contracts that are below the option in-the-money threshold shall go unexercised except if a Clearing Member informs OCC that the contract shall be exercised. The OCC reserves the right to determine which stocks will be included and which stocks will not be included in the ex-by-ex. Note, however, that despite the ex-by-ex, the holder still has the obligation to instruct his broker to give an exercise notice to the OCC.
LEAPS
LEAPS or Long term Equity AnticiPation Securities, also known as long term stock options, is a kind of stock option that gives its holder the right to buy or sell shares of stocks for a specified price with up to three years before expiration. LEAPS can be either calls or puts and are American style, which means that they can be exercised any time before or at the expiration date. Investors choose LEAPS because they give a longer opportunity to speculate and hedge on a particular stock. The expiration of LEAPS are similar with other stock options. All equity LEAPS’ expiration date is the third Saturday of January.